How Fed Rate Action Impacts Indian Equity Markets

“When America sneezes, the world catches a cold,” goes a French-origin phrase. This phrase is often used to explain the ripple effect of the US action on policy and politics around the world. The US Federal Reserve rate hike is the talk of the market these days. Fed is the central bank of a global leader, so its policy decision not only affects the US but affects global markets, including India, as well. Let’s understand how the Fed rate action impacts the Indian equity market.

Global Ripples

In December 2021, when the Federal Reserve said it would end its pandemic-era bond purchases in March and pave the way for three quarter-percentage-point interest rate hikes by the end of 2022. Interestingly, consumer price inflation in the US is running at a 40-year high. Usually, interest rate hikes are expected to reduce inflationary pressure. Post this announcement, investors across the world are rattled as the Fed could hike interest rates aggressively. Therefore, stock markets across the world, including India, are witnessing higher volatility.

Impact on The Indian Equity Market

The Indian markets keenly scrutinized the policy actions in the US as foreign portfolio investors (FPI) invest significantly in India as it is an emerging market. According to the National Securities Depository Limited (NSDL) data, FPI investment in India stood at Rs 50,089 crore in calendar year 2021.

More Opportunities, More Money

The US being a developed market, it offers limited growth opportunity, so investors look at high-growth developing markets like India to earn better returns.  Also, interest rates in the US are much lower than those in India and because of this spread, they borrow in the US and infuse capital in the Indian markets to capitalise on higher growth potential and better rate spread. When there is a hike in interest rates in the US market, the spread will be narrowed. This would translate into reverse flow, which means FPIs may start unwinding their positions in the Indian market. All this leads to market volatility.

Weaker Rupee

The US dollar gets stronger with rate hikes. Therefore, when FPIs pull money out of the equity and bond markets, the rupee weakens further. This results in lower return on portfolio for FPIs, which again results in higher selling pressure in the market.

Panic Selling

When markets fall back on FPI selling pressure, domestic investors also start selling in panic. This adds fuel to the fire. Because of higher selling pressure around the corner, markets turn highly volatile.

Additional Read: What to do when the market falls

Conclusion

While any hike in interest rates by the US Fed creates volatility in the market, it can’t affect the fundamentals of the equity market. This Fed-led volatility could be used as a market opportunity to invest more at lower price. It is also important to mention here that the trend of panic selling has reduced significantly which is evident from the trend that when FPIs are net sellers, domestic institutional investors are net buyers.

It may be true than when America sneezes, the world catches a cold, but then India catches only a mild cold.

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