Why India may come out on top after rate hike by US Federal Reserve

The US Federal Reserve's policy meeting (March 17-18) is the main focus for markets this week as the world waits to hear its intentions on interest rates.

Markets were rattled by US payroll and unemployment data for February due to fears that the Federal Reserve will raise interest rates sooner than expected, despite its pledge to be "patient" in its last policy meet.

However, what markets are not considering is that the US Fed will also look at core inflation in the US and the global macro-economic situation, the latter a cause of much concern, especially the euro zone. Also, except for unemployment data, other macro data from the US are consistently disappointing and volatile.

US Fed funds futures are indicating the probability of a rate hike in June at 19 per cent and 58 per cent for September. The key impact of a rate hike would be on the strength of the dollar. A strong dollar is "assumed" to have a negative macro impact on the US economy in terms of external trade, competitiveness of domestic industry and the profits accruing to US multinationals.

However, the effects of a strong dollar on the US economy can be argued with analysis of past data. Between 1982 and 2000, as the dollar skyrocketed 178 per cent, the country's stock markets jumped 1,099 per cent, and nearly 40 million jobs were added with 3.5 per cent average annual real GDP growth rate.

When the dollar declined from 2001 to 2011, a paltry 23 million jobs were added, real GDP growth averaged less than 2 per cent, and the S&P gained a measly 15 per cent. And let's not forget the dreadful 1970s when the dollar plunged, the economy suffered through years of stagflation, and the real value of stocks fell significantly.

As far as the rupee is concerned, as of last week, it was the only emerging markets currency which appreciated in the past year against the dollar, despite the dollar index hitting new highs every day in anticipation of a rate hike by the Federal Reserve. This can be attributed to the inherent strength of the Indian economy, supported by steady reforms being brought in by the BJP government and strong FPI inflows.

With key global rating agencies approving the reforms agenda of the government, the rupee will most likely outperform its peers when the Fed eventually hikes rates. This will prevent FPI outflows from India and will support the currency and markets. There is a case building up for India getting delinked from other major economies.

(Aviral has over 16 years of experience in Indian capital markets focusing on equities, having worked for both domestic and foreign institutional investors. He is a B Tech from IIT, Kanpur and a CFA from ICFAI, Hyderabad. Any opinions expressed here are the author's own.) - Reuters