Ind-Ra: Fed Hike Positive for Indian Bonds and Currency

The US Federal Reserve's decision to formally mark the end of its unconventional monetary policy is a welcome sign of normalisation, which will augur well for domestic financial markets, says India Ratings and Research (Ind-Ra). The US Federal Reserve has raised interest rates by 25bp - its first increase since 2006. Indian rates and currency market will stand to gain in the near term; the 10Y benchmark G-sec yield is likely to soften around the 7.70% levels with a bias towards a further softening of yields and the Indian rupee will stabilise between 66.3-66.6/USD during the week. With the Fed's policy normalisation underway, the Reserve Bank of India's (RBI) focus during the upcoming monetary policy reviews will increasingly shift to domestic parameters- the most critical being the growth-inflation rhetoric.

For financial markets, with the looming uncertainty over the Fed policy path behind, the drivers for markets hereon will be more inward focused rather than external development reliant.

The rate markets in the near term are likely to stabilise hereon on the back of (1) no supply pressure of G-sec in this fortnight (2) the next tranche of debt limit hike for portfolio investors for both central and state government bonds opening on 1 January 2016 (3) gradual and non-disruptive rate hikes by Fed in 2016 keeping the door open for RBI to ease rates, basis assessment of the evolving macroeconomic parameters.

The elimination of uncertainty post the Fed event emerges as a major positive for domestic bond market, which has been witnessing foreign outflow. Since November 2015- till the first week of December 2015, foreign institutional investors pulled out funds from equities worth around USD1.7bn and debt of USD580m. Incrementally, outflows from the Indian markets are likely to moderate. Ind-Ra believes that the future inflows are likely to be more long-term than 'hot' money.

As far as the Indian rupee is concern, Ind-Ra has been highlighting that the rupee is likely to correct from the recent lows of 67/USD to around 66.3-66.6/USD mark (DebtFX). A dovish rate hike by the Fed is likely to be positive for the emerging market forex space as questions persist not only over the timing of further rate hikes but also on the extent. The first rate hike comes against the backdrop of low inflation (in part, explained by 'transitory' pressure of energy prices). The US dollar weakness, consequently, may be an interim phenomenon with subsequent rate hikes likely to shift the orbit of dollar strength outward.

The rupee is likely to emerge as a gainer in the near term. Ind-Ra believes the rupee is likely to gain in today's trading session and consolidate in the 66.3-66.6/USD range. Its better placed macroeconomic fundamentals indicate that the rupee may continue to outperform both in absolute and relative terms.

On the ground level, the impact of policy normalisation by Fed is unlikely to have any fundamental shift in the outlook for the Indian economy. Indian corporate sectors continue to face pressure of over-leverage at a time when growth recovery is protracted, leaving a debt overhang. An appreciation in the currency, accompanied by low energy prices, will have a salutary impact on corporate balance sheets. Any meaningful turnaround, however, is likely to be slow and gradual.

The Fed rate hike and the revision of the 2016 growth forecast for US to 2.4% from 2.3% earlier needs to be assessed as the reasonable confidence US policymakers have on the revival of their domestic growth conditions. While other major economies continue to battle recessionary trends, the US economy's strength may have positive spillovers for its trading partners.

The stabilisation of the external market conditions lays the foundation for domestic policymakers to revive the issues plaguing the corporate sector. The government can focus on resolving the problem of stressed assets, creating demand and augmenting the capital expenditure plans.

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