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NEW DELHI/MUMBAI : India’s currency tumbled past the key level of 80 a dollar to a record low, while shares fell after the US Federal Reserve raised interest rate and signalled that it would pursue additional large hikes until it regained control of inflation.

The Indian rupee hit a record low of 80.87 against the dollar, while stocks fell for the second straight day, with benchmark indices Nifty and Sensex declining by 0.5% and 0.57%, respectively.

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The sustained strength of the dollar is piling pressure on the Indian central bank to defend the rupee, although its depleting dollar reserves leave it with less firepower as capital flees to dollar assets. Rising US interest rates make dollar assets more attractive and increase the risk of capital flight from India and other emerging markets.

On Wednesday, the Fed lifted the interest rate by 0.75 percentage points for the third consecutive time and forecast a further 1.25 percentage points of tightening by December end. And, in the clearest indication so far, Fed officials signalled they are willing to make sizable rate increases even if they risk a recession.

The Fed’s hawkish stance prompted central banks in Indonesia, Vietnam and the Philippines to raise interest rates on Thursday. It is also likely to add pressure on the Reserve Bank of India (RBI) to continue on the aggressive rate hike path to ease the pressure on the rupee. The RBI’s monetary policy panel will meet next week.

The only redeeming factor for the domestic markets remains softer crude prices.

“Now, the market feels the probability of a US recession has increased to 75%. Against the backdrop of sharply slowing euro zone and China, this is bad news for global growth," said V.K. Vijayakumar, chief investment strategist at Geojit Financial Services.

Moreover, the US 10-year bond yield spiking above 3.5% and the dollar index above 111 are unnerving for equity markets, he added.

Sugandha Sachdeva, vice-president at commodity and currency research, Religare Broking Ltd, said slowing portfolio flows have accentuated the decline in the rupee-dollar exchange rate, even as weakening crude oil prices are capping losses.

As a stronger dollar triggers outflows, RBI may raise rates aggressively, keeping markets volatile.

“If we start seeing rupee depreciating, then India becomes unattractive from a dollar returns perspective. We could also witness a reversal of foreign investment flows in the near to medium term, which will increase market volatility," said Naveen Kulkarni, chief investment officer at Axis Securities PMS. In addition, higher interest rates in the US will force major central banks, including India, to increase interest rates to stem the pressure on their domestic currencies, added Kulkarni.

According to provisional figures, foreign portfolio investors (FPIs) were net sellers worth 2,510 crore of equities on Thursday. In the previous three days, they were net sellers of more than 1,300 crore.

The Indian market’s resilience amid the global risk-off sentiment will now be tested, analysts said.

Robust growth expectations, better inflation control and rupee outperformance versus emerging markets have helped Indian markets outperform their peers. On the positive side, Brent below $90 a barrel accrued benefits for the Indian economy and inflation control.

Kunal Vora, head of India equity research at BNP Paribas, expects the Nifty to trade in a 17,000-18,000 range over the next year, with risks to the downside given the global headwinds like aggressive rate hikes, quantitative tightening and risk to earnings from slowing global growth.

“The gap between the 10-year G-Sec and next 12-month Nifty earnings yield is now 2%, which makes bonds more attractive than equities. If India’s inclusion in EM Bond Index doesn’t happen, this could move to 2.3-2.4%," Vora added.

Meanwhile, certain market experts appear to be optimistic.

“In the past decade through 2021, US equities outperformed Indian peers by a wide margin, thanks to easy liquidity conditions. Ergo, when easy liquidity begins to be withdrawn, the brunt will be borne by the guy who did the best. The effect on India will be extremely muted. I think we could head for a new high on the Nifty over a year," said Shankar Sharma, co-founder and vice-chairman of First Global.

The current setup is a ‘buy on dips’ market, and investors should use volatility in the coming weeks in a phased manner to build a position with a view of 12-18 months in quality companies where earnings visibility is very high, said Neeraj Chadawar, head of quantitative equity research, Axis Securities. In this context, domestic-oriented themes such as banks, consumer goods, hospitals, domestic industrials and discretionary consumption are well placed over export and cyclical-oriented themes.

Recessionary fears could keep globally linked sectors such as information technology, metals and pharma under pressure for some time. On the other hand, consumption and crude inputs sectors such as fast-moving consumer goods, paints, tyres, and autos will likely benefit from strong domestic demand and a fall in commodity prices.

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