India will not be immune from the impact of the 25 basis point hike in interest rates by the US Federal Reserve, but Asia’s third largest economy is better placed than most of its rivals and could actually see a gain in the bonds and rupee markets, say analysts.
The equity markets early Thursday welcomed the rate hike with the benchmark Sensex opening up more than 100 points, before recovering from the highs to factor in other local negatives such as the adverse impact on the auto industry from a recent court-ordered ban on diesel engines in Delhi.
“India is better placed than most of its peers,” says Thomas Rookmaaker, director (sovereign ratings) at Fitch Ratings. “First, its external balances have significantly improved since mid-2013, with foreign exchange reserves rising by about $65bn to $353bn as of November 2015 and the current account deficit narrowing. Second, India is less dependent than several of its peers on commodity exports, and has thus not been negatively affected by the global rout in commodity prices. Third, only a small part of India’s sovereign debt is held by foreigners or is denominated in foreign currency. Fourth, India’s favourable economic growth outlook makes India relatively attractive for foreign investors.”
The US Federal Reserve on Wednesday raised the range of its benchmark interest rate by 25 basis points to between 0.25 and 0.50%. This is the first hike in nine years and sends out a positive signal about the revival in the world’s largest economy, which would have a corresponding positive impact on the rest of the world.
“The US Federal Reserve’s decision to mark the end of its unconventional monetary policy is a welcome sign of normalization which will augur well for domestic financial markets,” says India Ratings and Research analyst Bansi Madhavani. “Specifically, rates and currency market will stand to gain in the near term with bond yields likely to soften and the Indian rupee stabilise between 66.3-66.6 to the dollar during the week,” he added.
The Indian rupee has seen some nervous pull downs in the week before the US Fed decision, with the currency falling to a two-and-a-half year low of 67.10 to the dollar on Dec 14, on fears that the rate hike would sharply strengthen the dollar. This had also fuelled speculation that the RBI would aggressively intervene in Indian forex markets to stabilize the Indian currency. While the fears haven’t died down, Madhavani says that “with Fed’s policy normalisation underway, now the RBI’s focus during the upcoming monetary policy reviews will increasingly shift to domestic parameters - critical being the growth-inflation rhetoric.”
According to an India Ratings research, the rates market in the near term is likely to stabilise on the back of no supply pressure of G-sec (government securities) in the current fortnight, from the next tranche of debt limit hike for portfolio investors for central and state government bonds, and also from the gradual rate hikes by Fed in 2016 keeping the door open for RBI to ease rates.
“The elimination of uncertainty post the Fed event emerges as a major positive for domestic bond market which has been witnessing foreign outflow,” Madhavani added. Over November 2015 and the first week of December 2015, equity outflow stood at around $1.7 billion, while debt outflow totaled $580 million. Incrementally, outflow from India is likely to moderate.
“In the currency space, we have been highlighting that the rupee is likely to correct from the recent lows of 67 to the dollar to around 66.3-66.6 to the dollar. A dovish rate hike by Fed is likely to be positive for the emerging markets forex space as questions persist not only over the timing of further rate hikes but also on the extent,” Madhavani.
The rupee is likely to emerge as a gainer in the near term. India Ratings believes the rupee is likely to gain in Thursday’s trading session and consolidate in the 66.3-66.6 range. Its better placed macro fundamentals indicate that the rupee could continue outperforming both in absolute and relative terms.