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How US Fed can Affect Indian Markets

The US Fed has given clear signals that it will soon start raising interest rates. This could make Indian markets less attractive for FIIs

The US Federal Reserve, in its latest policy statement, indicated that it could hike rates going forward. Interest rates are important because FIIs measure the attractiveness of bonds vis-à-vis foreign equity. Also, rate hikes in the past have caused global equity sell-offs, especially in emerging economies. There are two broad views about the impending rate hikes.

The first says that the spread between interest rates in the US and those in the Indian markets are large enough to bear a rate hike or two, especially if the hike is a minor one. But a couple of rate hikes down the road could erode the gap that makes Indian markets attractive. In such an eventuality, the risk of flight of capital is very real as was last seen in 2013, when the Fed first talked of ending its quantitative easing programme.

The other view is a more optimistic one, according to which the rate hikes, when they happen, would be a very gradual process, giving enough time for markets to adjust. Besides, there are a few positives on our side. Despite the slowdown, our economy is still among the fastest growing in the world and steady improvement will foster the India growth story. There's comfort in forex reserves too that hit an all-time high of $343 billion on April 3, as a result of which the rupee has been less affected as other global currencies have been with the strengthening of the US dollar. Any improvement in the economy will make the country more attractive vis-à-vis other emerging economies that are reeling from fall in demand and lower crude prices.

Where to invest your money?
Two sectors - pharma and technology - in general have better prospects than others do. If you need to invest now, look at these two sectors. For technology, the global IT demand is looking better this year than last and the BFSI (banking, financial institutions and insurance) sector - one of the biggest revenue streams for Indian technology firms - is looking up after a lacklustre 2014. For pharma, a number of big drugs are going off-patent in the US. Steady gains made by domestic pharma companies in the generic space continue to benefit the sector. Though valuations have heated up in these two sectors, they have the best earnings growth profile in the foreseeable future.

Spaces to avoid would be capital goods where valuations appear far higher than sustainable earnings would support; and oil and gas, where there is no telling where crude will move and how the fortunes of sector companies could be impacted. FMCG sector valuations are already at lifetime highs and the sector has started showing signs of slowdown. Metals and commodities, in general, could remain weak following global slowdown, especially in China, while utilities could continue to languish without any path-breaking reforms. With telecom, one really does not know when the sector will start making money in the face of heavy investments in spectrum and other infrastructure. But pharma and technology continue to remain attractive.