Room for smaller interest rate hikes

The Indian stock market was a standout in a sea of declines on Wednesday as markets prepared for more aggressive interest rate increases by the US Federal Reserve to stamp out stubborn inflation. Projections for the terminal US policy rate are being revised upwards as inflation refuses to moderate, pushing up treasury yields and the dollar, and draining money from risky assets like equities.

India‘s outperformance can very broadly be broken down to three structural factors. One, the Indian economy is different from a decade ago with low corporate indebtedness and a banking system declogged of bad loans. Two, a sputtering Chinese economy is diverting the tide of foreign capital to other emerging economies. Three, there has been a ratcheting up of household savings into equities due to the wealth effect.

Feeding into these is the market’s understanding that oil prices may have peaked. This allows India room for smaller interest rate hikes with a narrower spread between the initial and terminal rates. Improved tax collection, likewise, creates space for infrastructure spending expected to revive private capital expenditure.

Electronic exports, beneficiaries of domestic manufacturing incentives and competitive tax rates, are signalling India’s place in a world seeking supply chain resilience. Finally, global trade fragmentation is unlikely to affect IT services as much as it has factory output.

But all of these do not decouple the Indian stock market from the rest of the world. The gap between gilt yields and equity earnings is signalling a correction. Indian equity valuations are becoming richer as prospects dim for it meeting the target GDP growth for the year. Structural factors can, at best, cushion Indian stock market volatility.

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