With improving domestic fundamentals Indian markets not too vulnerable to US rate hikes

The rate increases expected to be announced by the US Federal Reserve’s Federal Open Market Committee next year might not bring much gloom for India. It is likely there will be a knee-jerk reaction alone, as domestic fundamentals are increasingly improving. Experts say the Reserve Bank of India (RBI) is keeping a close watch on the rupee, adding the bond market might continue to attract foreign investors.

It is expected at its meeting on Tuesday and Wednesday, the Federal Open Market Committee will announce an end to its asset-purchase programme. The scale of the programme, once $85 billion a month, is now down to $15 billion a month.

Experts say rate increases by the US are still far. “I go by market conviction that the US Fed might not raise interest rates before mid-2015. Data from the US are quite mixed, though positive news items outweigh negative ones,” said Rupa Rege Nitsure, chief economist and general manager, Bank of Baroda.

At a meeting of RBI’s technical advisory committee, members said India could benefit from a strong revival in US growth, because the beneficial effects of higher trade and investment would, at least in part, offset the adverse impact of expected capital outflows in response to tightening of monetary policy by the US Federal Reserve.

In recent times, the markets have factored in some of the Fed’s expected action. “The fact that the Fed will eventually raise rates is well appreciated in the market. For India, economic fundamentals are a lot stronger. RBI has added substantially to its reserves, which it could use to temper any knee-jerk depreciation pressure on the rupee. Therefore, while we will see some market reaction in both foreign exchange and rates to those events, it will be far more muted than what we saw last year,” said Brijen Puri, executive director and head of markets, JP Morgan.

Latest RBI data show foreign exchange reserves rose by $945.6 million to $313.68 billion in the week ended October 17. The reserves are much higher than in 2013.

Puri says while the government continues on its path of fiscal moderation, RBI continues to keep a watch on inflation. The rupee, he says, is stable and the current account deficit is muted; as such, investors will be keen to increase exposure to Indian debt markets.

RBI aims to reduce Consumer Price Index-based inflation to six per cent by January 2016. In September, it fell to 6.46 per cent, lowest since January 2012, owing to the falling prices of fruit and vegetables. For this financial year, the government’s fiscal deficit has been pegged at 4.1 per cent of gross domestic product (GDP), and it is expected this target will be met. RBI expects GDP growth of five-six per cent this financial year.

Shubhada Rao, senior president and chief economist, YES Bank, said, “Global liquidity is not totally drying up and, barring the initial turbulence we might witness at the time of a rate increase, global liquidity will seek areas of high growth and better returns. In that context, we expect India to remain a favourable destination.”