Five reasons why India well-prepared to weather next Fed rate hike in US

US Federal Reserve Chair Janet Yellen may have sounded the bugle on the next rate hike in US in her Jackson Hole speech last week, but she remained agnostic on the specific timing. Though, domestic stock and money market may react negatively in the short-term whenever she raises the interest rates, there is little reason for India to fuss over rate hike, consequently foreign portfolio investment (FPI) outflows, even if Fed presses the button in September.

We have compiled five reasons why India is better placed to undergo any eventuality of Fed rate hike:

1) Forex reserves at all-time high

The country's foreign exchange reserves increased by a healthy $1.34 billion to touch a record high of $367.169 billion in the week to August 19 mainly due to a rise in foreign currency assets (FCAs). That said, even if US investors exit Indian shores in the event of a rate hike in US, strong forex reserve will arrest the possible fall in rupee. Though, there are concerns over foreign currency non-resident (FCNR) deposits, which will come up for redemption starting September, RBI's repeated assurance to handle the situation has allayed fears to some extent.

India did manage to restrict losses in 2015 and is in fact trading at valuations, some analysts believe are stretched. That said, hopes of a rebound in earnings cycle back home have maintained India's attractiveness among foreign and domestic funds alike.

"As far as valuations go, we have seen Nifty50's valuations stretching to 23 odd levels after falling to 18-odd levels in 2015. It means the valuations have jumped over 25 per cent since last year," said Mustafa Nadeem, CEO, Epic Research.

4) Economic fundamentals have improved

Other than better monsoon and pay hike for government employees, a couple of other key reforms such as Goods and Services Tax (GST) Bill and government's approval on inflation targeting makes India attractive to foreign investors. Recently Goldman Sachs said the Indian economy is expected to clock 7.9 per cent growth in the current fiscal year.

The country's real GDP growth accelerated to 7.9 per cent year-on-year in the first quarter of this year and recorded a five-year high growth rate of 7.6 per cent for the 2015-16 fiscal on robust manufacturing growth.  

5) Arbitrage gain

Arbitrage is buying in one market and simultaneously selling in another, profiting from a temporary difference. Thus, one of the reasons why FIIs pump in money in emerging markets such as India is to catch on arbitrage gain i.e. to exploit the difference between the higher interest rates in EMs from the lower interest rates in their countries. While a rate hike in US will lower the arbitrage gain for US investors, it will still stay significant given the possible gradual hike in US.

"As the rate hike in US will be gradual and it could only be another 25 bps. That could still leave a significant arbitrage opportunity in India for FIIs," said G Chokkalingam, Founder, Equinomics Research & Advisory.