Implications for India’s monetary policy
The Reserve Bank of India (RBI) faces a delicate balancing act. With the Fed signalling a slower pace of rate cuts in 2025, foreign capital inflows into India could diminish, especially as US treasury yields become increasingly attractive. This may prompt the RBI to consider steps to stabilize the rupee and manage inflationary pressures. The Fed’s decision adds complexity to RBI’s Monetary Policy Committee (MPC) deliberations, making a February 2025 repo rate cut less certain.
Moreover, the recent 50bps cut in the cash reserve ratio (CRR) reflects an effort to inject liquidity into the banking system. This measure, combined with falling interest rates globally, could support domestic economic growth. However, the interplay between global cues and domestic inflation will be pivotal in shaping the central bank’s next steps.
Impact on asset classes in India
Equities: Indian stock markets have already reacted negatively to the Fed’s hawkish outlook, with benchmark indices Sensex and Nifty witnessing sharp declines. On 19 December, the Sensex crashed 1,153.17 points, or 1.44%, to open at 79,029.03, while the Nifty 50 opened at 23,877.15, down 321.70 points, or 1.33%. The potential for reduced foreign capital inflows is a concern as the US debt market, with its more attractive returns, becomes a stronger alternative. This triggers the likelihood of a near-term pullback in the market, as the Fed’s less dovish stance increases uncertainty in the investment environment.
Reduced foreign institutional investor (FII) participation could pressure large-cap stocks. While large-cap stocks are often seen as a safe bet, they may not be entirely insulated from potential outflows, given the larger investments by FIIs. As such, investors may need to consider sector-specific strategies.
Sectors like IT and pharmaceuticals, which benefit from export revenue, may emerge as safer bets in this volatile environment. Mid- and small-cap stocks, on the other hand, could see heightened risk, requiring investors to tread carefully. With valuations already somewhat elevated, identifying the right companies will require precision. However, the long-term growth story of India remains intact, and the market is expected to stabilize, giving investors a chance to pick up quality stocks at lower prices.
Commodities and currencies: The US dollar’s strength and rising treasury yields have exerted downward pressure on precious metals. Gold prices, for instance, recently dipped near $2,600 per ounce. Silver is also feeling the strain, trading at $29.45 per ounce. The Indian rupee, which recently breached the 85-mark against the dollar, may experience further depreciation, increasing import costs and potentially pushing inflation higher. The rupee’s fall past 85 to the US dollar for the first time in early December after the Fed’s hawkish outlook underscores this trend.
Fixed income instruments: The bond market could witness a mixed response. Lower CRR and an accommodative stance by the RBI might reduce borrowing costs, spurring demand for government and corporate bonds. Yields on long-term bonds are expected to decline, benefiting fixed-income investors. However, global volatility may lead to sporadic fluctuations in yields.
The bond market’s role in the current environment
As interest rates fall, the bond market becomes a focal point for both institutional and retail investors. Lower yields on fixed deposits and other traditional savings instruments make bonds an attractive alternative. Government securities, AAA-rated corporate bonds, and debt mutual funds are likely to see increased investor interest. For those looking to hedge against volatility, short-duration funds could offer stability with moderate returns.
What should retail investors do?
In this complex environment, retail investors should adopt a cautious yet strategic approach:
Diversify across asset classes, balancing equities, fixed-income instruments, and commodities.
Focus on quality by prioritizing investments in sectors with export-oriented growth potential or companies with strong fundamentals.
Consider bonds and debt funds as they offer stability and relatively predictable returns.
Stay liquid to capitalize on opportunities during market corrections.
Monitor global cues, especially US monetary policy trends, which are likely to shape India’s financial landscape in the near term.
The US Fed’s rate cut marks a significant moment for global markets and India’s monetary policy. While uncertainty looms large, India’s long-term growth story remains intact. By adopting a well-informed and balanced strategy, retail investors can navigate this challenging phase and position themselves for future gains.
It is always advisable to consult a registered financial advisor and read the offer documents carefully before making any investment decisions.
Views are personal.
Irfan Mohammed is executive director and COO at Aspero.
