How Fed's rate hike could trigger foreign investor exodus
What's the story
The US Federal Reserve has raised its benchmark interest rate by 25 basis points, marking the first hike since 2023. The move comes as inflation continues to exceed the central bank's target of 2%. The decision could have implications for foreign portfolio investments (FPI) in India, with higher US yields and a stronger dollar potentially making Indian assets less attractive.
Market implications
Impact on Indian assets
The Fed's latest projections indicate that 16 out of 18 policymakers expect at least one more rate hike this year.
This could push up Treasury yields and increase returns on US dollar assets.
If these yields remain high, global investors may become choosy about emerging markets like India.
However, it's not an automatic effect, as factors like India's growth outlook and corporate earnings also play a role in investor decisions.
Investor response
FPIs cautious toward Indian equities
After the Fed's decision, the US 10-year Treasury yield stood at around 5%, with the two-year yield also rising. The dollar strengthened post-announcement.
FPIs have already been cautious toward Indian equities, selling around ₹14,475 crore worth of stocks in September till mid-month.
This trend follows purchases in July and August amid rising crude prices and global bond yields.
Market pressure
Higher US yields could lessen yield advantage of Indian bonds
If Treasury yields rise further, investors may seek a higher return from Indian assets to offset the additional risk.
This could put pressure on equity valuations, especially in segments with high valuations and where future earnings account for a large part of the stock price.
Higher US yields could also lessen the yield advantage of Indian bonds for overseas investors.
Currency impact
Rupee under pressure against dollar
The rupee closed at ₹95.9550 against the dollar on Wednesday, its weakest level since late July.
The currency has been under pressure from strong dollar demand, elevated oil prices, and expectations of tighter US monetary policy.
A weaker rupee can affect FPI returns as overseas investors ultimately measure their returns in dollar terms.
Higher crude prices also increase India's demand for dollars to pay for imports, further pressuring the rupee if coupled with a stronger US dollar.