Mumbai: The US Federal Reserve on Wednesday kept interest rate unchanged as expected, but a series of upcoming Fed rate hikes could drive up the dollar and prompt foreign investors to withdraw money from Indian markets, brokerages said.
At a two-day meet of its rate-setting panel headed by chairman Jerome Powell, the US Fed kept its benchmark overnight lending rate in a target range of 1.50-1.75%. However, the rise in the US inflation indicates the central bank will raise the rate at its next meeting on 12-13 June as expected.
The Fed raised rates in March and has forecast another two increases this year, although an increasing number of policymakers expect it could be three. Investors expect a rate hike at the June policy meeting. Powell has maintained that the central bank will pursue a middle-of-the-road approach to monetary policy, continuing to gradually lift rates in the face of a robust economy that is yet to spark a jump in inflation.
According to Kotak Securities Ltd, the rise in US yields and the hike in interest rates can push the dollar further higher, triggering selling by foreign institutional investors (FIIs). It said in a 2 May report that US Treasury yields moved above 3% in April on the prospects of higher US real gross domestic product (GDP) growth, expected Fed interest rate hikes and higher US inflation. “From an Indian standpoint, there could be an impact on our forex reserves and currency as declining interest rate differential between Indian and US debt could trigger outflows from Indian debt market instruments,” the brokerage firm said.
FIIs were net sellers of Indian equities in April while domestic institutional investors (DII) continued to buy. The Sensex is up 3.07% in the year so far after a sharp correction due to heavy selling that started at the end of January. Hopes of a revival in earnings growth, following disruptions caused by demonetization and the implementation of goods and services tax (GST) in July last year, have returned.
In April, FIIs were net sellers of Indian shares worth $943.32 million. They pulled out $1,957.75 million from Indian equities in February before buying $2,027.52 million worth of shares in March. In contrast, DIIs have been actively buying. They have bought shares worth Rs17,813.01 crore, Rs6,693.91 crore and Rs8,511.33 crore in February, March and April respectively.
Ajay Bodke, chief executive and chief portfolio manager, Prabhudas Lilladher Pvt. Ltd said that though FIIs flows have slowed down, domestic money has been able to cushion the outflow. He believes FIIs are unlikely to be perturbed after March quarter earnings and will soon return to India. Fourth quarter earnings of FY18 are estimated to be better as early trends have shown a pick-up in growth.
“As long as international interest rate trajectory is at a measured pace and as per consensus, I don’t see any disruptions and dislocation in the markets. Among many factors that influence foreign inflow of funds is the differential rates between US and the destination country, hence post a rate hike by the US central bank increases possibility of a slowdown and reversal of flows can’t be ruled out,” Bodke told Mint.
Emkay Global Financial Services Ltd said that strengthening case for Fed monetary policy normalization is now laying the backdrop for a stronger dollar.
“The global economic recovery since mid-2016 has been US-centric, gradually extending to other major economies, notably Europe and Japan and eventually to emerging markets (EMs), including China and India. Sharp steps taken by the Trump administration towards hastening the global rebalancing, protectionist measures and country-specific exchange rate management can revive markets volatility,” it said in a note on 30 April. Emkay added that gradual tapering of the US Fed balance sheet and hardening of US treasury yields are factors that might adversely affect portfolio flows into EMs, thereby leading to pressure on currencies. A recent IMF study has shown that 75% of portfolio flows into EMs are attributable to Fed’s balance sheet expansion and ultra-low Fed rate.
Morgan Stanley Research agrees. “We expect multiples to remain constrained by monetary policy tightening in the US and China and uncertainty over protectionism. Consensus earnings estimates still look too high, in our view, and the macro backdrop is deteriorating,” Morgan Stanley Research said in a note on 2 May.livemint