The Fed non-event and Indian equities

In one of the most keenly awaited decisions, the US Federal Reserve last week decided to stay put on interest rates, citing concerns on the health of the global economy and persistence of low domestic inflation. While most markets corrected on this news, Indian equities celebrated with a more than one per cent rise in the Nifty. Deferral of what looked like a near-certain rate hike by the Fed, based partly on China concerns, possibly suggests that there is more to the China problem than what the markets have factored in. After all, China is an important engine of global growth, contributing over a quarter of global growth since the global meltdown of 2008.

Over the past seven weeks, foreign investors have been net sellers of Indian equities, having shed stocks worth $4 billion. Despite robust domestic institutional buying, the Nifty has corrected by some 12 per cent since its March 2015 peak. There has been a general surge in emerging market outflows consequent to the rumblings in the Chinese economy and expectations of US Fed action, and nearer home, because of the legislative logjam in Parliament, a deficient monsoon and the slowdown on the international trade.

Despite this, there have been virtually no FII (foreign institutional investors) outflows from the Indian debt market since May and this can change with a contraction in interest rate differentials, either by softening Indian or firmer US interest rates, which, in turn, could lead to increased forex risks. The recent Nifty correction has possibly factored in some of these negatives.

What then can be expected from Indian equities over the rest of the current financial year? Assuming the sell-off over the last couple of months was partly in preparation for a Fed interest rate hike, given the Fed's dovish stance on interest rates, further large outflows might be unlikely in the short term if the Chinese can manage to quell the turmoil in their economy in quick time. Valuations at around 13 times FY17 earnings are not too demanding if earnings growth catches up on the back of an easing domestic interest rate cycle and purposeful policy action.

Accelerating the growth momentum needs a quick resolution of the serious stressed assets problem in the banking sector, for which de-bottlenecking delayed projects, restructuring the state electricity boards/companies, addressing the travails of the power and metals sectors and streamlining resource allocation processes are imperative. After the setback on the legislative front, the government seems to have redoubled its efforts in reviving the investment cycle by accelerating public investments in roads and railways, while pushing for large investments in capacity creation by public sector units. These efforts should start showing some results over the next few months which could be the harbinger of good times for equities.

On balance, subject to the caveats of a possible escalation of the China problem and continuing FII outflows, Indian equities should hold steady over the next couple of quarters on the back of easing domestic interest rates, an upswing in the investment cycle, a modest improvement in the growth momentum and a possible uptick in corporate earnings. Investors would be advised to stay invested while keeping a close watch on international developments.

The author is director, Dalton Capital Advisors (India) Pvt. Ltd.