Increase in U.S. Interests Stirs Anxiety in the Indian Stock Market
The Indian equity markets are currently experiencing a correction, with the SENSEX witnessing a decline of around 6% over the last two weeks of January 2022. This correction can be attributed, in part, to the pullout of Foreign Institutional Investors (FIIs) from the Indian equity markets. However, the direct link between the US Federal Reserve's interest rate increase and the FII exodus is more about broader market dynamics and risk aversion, rather than a specific interest rate hike.
The US Federal Reserve's decision to increase interest rates is a response to inflation in the US, which reached a 40-year high in December 2021. This inflation has been caused by COVID-19-led supply disruptions and an increase in demand due to increased spending capabilities and government cheques.
The rising interest rates make it expensive for people to borrow and spend, and are used by central banks to cool off demand. The US Fed's decision to increase interest rates will result in a decrease in the money supply available to banks and other financial institutions. This, in turn, will further reduce liquidity in the system, making it less available for investing in risky assets like equities.
Moreover, the higher interest rates in the US can cause a decrease in the equity risk premium, making investing in equities less attractive. The US Fed's liquidity infusion, which allowed corporates and financial institutions in the US to have more and more money at their disposal, some of which was invested in stocks worldwide, including the Indian stock market, will now cease. This will further contribute to the decrease in liquidity available for investing in equities.
The pullout of FIIs from the Indian equity markets has not been directly attributed to the US Federal Reserve increasing interest rates in recent reports. However, some key factors contributing to their withdrawal include global economic uncertainty, valuation concerns, bond yield pressures, and shifting earnings landscape.
FIIs have been generally cautious due to global economic uncertainty, which includes the impact of rising interest rates worldwide. Higher interest rates can make safe-haven assets like bonds more attractive, potentially leading to a shift away from emerging market equities. Rising valuations in Indian equities have prompted FIIs to reassess their investments, particularly for sectors like IT and FMCG, where structural bets are being reevaluated due to high valuation multiples.
The increase in global bond yields, particularly in the US, has led to a broader trend of debt selloff in emerging markets. This has driven FIIs to reduce their exposure to Indian markets, as higher yields make fixed-income investments more appealing compared to equities. The expectation of a slowdown in IT spending in major markets like the US has also contributed to FII outflows. This shift in earnings expectations can lead investors to seek safer or more stable sectors.
For long-term investors, these episodes are considered "little bumps" and it is advised to stick to asset allocation and stay the course. The amount of correction or the time to bounce back from a stock market correction is unpredictable. It is important to remember that the Indian equity markets have bounced back in the following months after the 2013 correction.
The US Fed's policies leading to a correction in the Indian equity markets is not a new occurrence, as seen in the "Taper Tantrum" of May 2013. However, the Indian retail investors are regularly investing their money in the Indian equity market, which could limit the fall in the Indian equity markets even as FIIs pull out their investments.
In conclusion, the US Federal Reserve's decision to increase interest rates and stop the bond-buying program will have a significant impact on the global economy and financial markets, including the Indian equity markets. While the direct link between the US Fed's interest rate increase and the FII exodus from the Indian equity markets is more about broader market dynamics and risk aversion, it is crucial for investors to stay informed and adapt their strategies accordingly.
[1] https://www.livemint.com/markets/stocks/foreign-investors-pull-out-of-indian-stocks-as-valuations-rise-and-global-uncertainty-grows-11642578142914.html [3] https://www.bloombergquint.com/onweb/foreign-investors-pull-out-of-indian-stocks-as-valuations-rise-and-global-uncertainty-grows#gs.o7h1w4w
In light of the US Federal Reserve's decision to increase interest rates and decrease the liquidity infusion, investors may find fixed-income investments more attractive compared to equities, which could lead to a decrease in liquidity available for investing in risky assets like the Indian equities. Furthermore, the rising interest rates in the US can potentially cause a decrease in the equity risk premium, making investing in equities less attractive for various investors.
