Home / Markets / Stock Markets /  US Fed rate signal may impede foreign inflows into stocks

A potential rise in interest rates in the US by 2023 as signalled by the US Federal Reserve could slow down foreign fund flows into India, even as domestic liquidity is expected to provide support to stocks.

The US central bank’s hawkish comments late on Wednesday night sent markets worldwide into a sell-off mode, as ultra-loose monetary policy stances by global central banks so far had flushed equities with abundant liquidity, especially during the pandemic.

On Thursday, Indian markets extended weakness for a second straight day. The BSE Sensex slipped 178.65 points or 0.34%, ending at 52,323.33. The Nifty was down 76.15 points or 0.48% at 15,691.40. Among shares in the Asia-Pacific, the Nikkei in Japan fell 0.93% while South Korea’s Kospi closed 0.42% lower.

Funds inflow
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Funds inflow

“Weak global cues along with weekly F&O (futures and options) contract expiry led to a volatile session. Metals continued to witness selling pressure after China announced intentions to release industrial metals from its national reserves to restrain commodity prices," Motilal Oswal said in a note.

Fed officials held interest rates near zero but signalled that it might raise interest rates at a much faster pace than assumed, sending yields and the dollar sharply higher. Indicating that broad changes in policy may happen sooner than expected, US central bank officials moved their first projected rate increases from 2024 into 2023. The Fed policy statement marked a strong vote of confidence that the recovery of the US economy is on track.

India and other emerging markets may face some pressure as they can be vulnerable to the chance of early US rate hikes to contain inflation, which could result in foreign investors pulling out of riskier assets, said experts. An actual rate hike, even if the Fed has brought forward the timeline to 2023, still remains some time away. Thus, the impact of Wednesday’s policy statement may be limited in the near term.

Foreign institutional investors (FIIs) have pumped $8 billion into Indian equities so far this year while benchmark indices have been hitting record highs. “While the fast normalization of the economy and a strong job market can lead to a taper in the bond-buying plan, this can lead to tightening of bond yields, which will impact the pricing of equity assets," said Vinod Nair, head of research, Geojit Financial Services.

Typically, higher interest rates in the US tempt large foreign funds to move money there, hurting emerging markets. The exit of long-term money may be a cause of concern as markets rely on foreign fund flows for liquidity. In June, FIIs were net buyers of Indian shares worth $1.63 billion, being net sellers only in April when they dumped shares worth $1.48 billion.

Others feel domestic institutional flows are strong enough to support the market in the absence of liquidity from FIIs.

“In the short term, the Fed rate action may impact negatively if the dollar index crosses the level of $92. However, the current rally or current inflation is demand-pulled and at major levels, value-pickers would enter with a long-term view. In the short term, we might see correction, but in the long run, we expect flows because of expectations of a good monsoon, a rise in goods and services tax collection and consistency in the reform process," said Shrikant Chouhan, executive vice-president, Equity Technical Research, Kotak Securities.

So far, Indian markets have outperformed emerging markets, with the benchmark index Nifty rising 11% while the MSCI Emerging Markets index has gained 6%. MSCI World, which represents large and mid-cap equity performance across 23 developed markets, has climbed 12% in 2021 so far.

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