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US Rate Hike: 3 risks to India
India is one of the most preferred investment destinations in the world. This is the reason for the substantial flow of foreign portfolio funds into the Indian market. However, the Indian market is going through a consolidation phase.
It is not just because of domestic events, but also global cues. The US Federal Reserve recently hinted at an interest rate hike as soon as mid2015. The US central bank did so by removing the word 'patient' in its postmeeting announcement.
The last time the US Fed announced a tighter monetary policy - the rollback of the Quantitative easing programme - Indian markets and rupee crashed. This shows the Fed's policies can impact India too.
Here's a look at how India could be affected this time around:
After the US Fed's announcement, neither the Indian markets nor rupee reacted drastically. Yet, experts suggest the currency could see some kneejerk reaction when the Fed announces an actual rate hike. "USD/INR is expected to see some depreciation pressure as the Fed raises interest rates-in line with other Asian currencies," according to a Kotak Securities report dated March 19, 2015. However, this is likely to be a shortterm reaction. The currency would soon stabilise unlike in 2013. This is because India's macroeconomic fundamentals are stronger than 2013. Moreover, India benefits from the sharp drop in global oil prices. The government's strong reform agenda too could attract foreign inflows compared to other emerging economies. This would lend strength to the rupee.
Inflation - the rise in prices over time - has remained under control in India and other Asian countries because of low global prices of oil. This allowed room for the Reserve Bank of India (RBI) to cut interest rates to stimulate growth. So far, the RBI cut interest rates by 0.5% in 2015. It is expected to cut rates further. However, there is a strong likelihood that the Fed's interest rate hike could limit the rate cuts in India. The RBI often prefers to play cautiously and cut rates only when there are low risks to inflation. It could prefer to watch the situation on the ground post the Fed's announcement and then proceed with a rate cut accordingly. This, in turn, could affect Indian markets, which always bat for a rate cut.
The US Fed's rate hike in itself may not affect the Indian markets much because of higher confidence in the Indian growth story. However, investors would definitely want to see economic growth translate into corporate profits. For this reason, earnings announcements would play a big role in shaping the market's momentum in the near future. If company earnings fail to meet expectations, especially when the Fed announces a hike, stocks could see major corrections. This is because the stock's price is linked to the company's profitability. If analysts lower their future profit expectations, it would affect forward PE ratios - a way of checking if shares are costly or cheap. Investors usually sell shares and book profits if shares are available at a costly rate.
The RBI holds foreign exchange reserves worth $338.1 billion. This is the highest ever for India. The RBI has been building its forex reserves ever since the rupee's free fall in 2013. The higher reserves can be sold in times of trouble to stabilise the rupee.