India to receive higher IFI inflows following US rate cut

Indian stocks could attract higher inflows from foreign investors this year, with the US Federal Reserve cutting its policy rate by a massive 50 basis points, the first cut in four years, and signalling another 50 basis point cut later in the year, according to analysts.

However, they rule out a runaway rally, given elevated valuations across large parts of the market, and expect large-cap financials to outperform broader markets, helped by domestic institutional flows and a possible rate cut by the Reserve Bank of India (RBI) by year-end.

“Generally, emerging markets (EM) like India tend to attract more foreign money in a low interest rate cycle, courtesy of a carry trade, which sees foreign institutional investors (FIIs) borrowing cheaper at home to invest in higher-yielding and riskier EM assets,” said Andrew Holland, CEO of Avendus Capital Alternate Strategies.

The Netherlands expects a gradual rather than a rapid rebound, with large lenders and shadow banks likely to outperform broader markets, which could witness profit-taking, a trend seen over the past few trading sessions and particularly on Thursday.

Nifty, Sensex Discs

Following the overnight Fed rate cut, the Nifty and Sensex surged to fresh record highs in the first hour of trading on Thursday, before sharply paring gains thereafter to close only marginally higher. The Nifty hit a fresh high of 25,611.95, up 0.9%, before erasing most of its gains to close 0.15% higher at 25,415.80. The Sensex similarly rallied a percentage point to a fresh high of 83,773.61 before paring gains to close 0.29% higher at 83,184.80.

Despite the modest rise, benchmark indices outperformed broader markets, where profit-taking dragged the Nifty Midcap 150 down half a percentage point to 21,965.15 and the Nifty Smallcap 250 down 1.11 per cent to 18,270.40.

HDFC Bank and Kotak Mahindra Bank contributed 0.13% to the Nifty’s 0.15% gain.

IFI entries in the current calendar year in ₹73,782 crores lag behind inflows from domestic institutional investors (DIIs) ₹3.2 trillion.

“While the 50 basis point cut was larger than expected, the 100 basis point cut signalled earlier for this year was priced in by the markets,” said Ashish Gupta, CIO at Axis AMC, citing the 10-year US bond yield which rose 3 basis points to 3.73% at the time of writing.

While Gupta does not expect markets to “get ahead of themselves,” he said lower “global rates” mean “a lower global cost of capital,” which is good for financial assets.

In fact, heavy buying of domestic and international stocks has pushed Indian stocks, especially small and midcaps, into highly overvalued territory. For instance, while the Nifty is currently trading at a price-to-earnings multiple of 24.82 times against a historical average of 24.73 times, the Nifty Midcap 150 is trading at a P/E multiple of 46.85 against a historical average of 36x, while the Nifty Smallcap 250 is trading at 35.78 times (28.7x).

Finding value in an overheated market

Citing overvaluations across sectors, Sanjeev Prasad, Co-Head and Managing Director, Kotak Institutional Equities, sees banks in the large-cap segment, which he termed as “overvalued”, as having “value”. He advised caution for investors in the broader markets as he sees small- and mid-cap companies as “highly overvalued”.

Meanwhile, the rupee gained 7 paise to close at 83.68 per dollar, while the 10-year Indian bond yield gained 9 basis points to a provisional close of 6.87%, reinforcing analysts’ views that the market had priced in a US interest rate cut.

Economists expect the RBI to keep rates steady at its next monetary policy committee meeting in October, given the focus on curbing food inflation, but is likely to cut policy in December. “I don’t think the MPC (monetary policy committee) will lower the repo rate as a reaction to the US Federal Reserve’s rate cut. Even last week, the RBI governor said that the rate cut will depend on the trajectory of inflation,” said Madan Sabnavis, chief economist at Bank of Baroda. “It would be interesting to see how the new MPC members view this decision by the Fed. However, a cut in December is possible.”

The government is expected to appoint new members to the Monetary Policy Committee in October, replacing those appointed in October 2020. According to Dharmakirti Joshi, chief economist at Crisil, India’s monetary policy depends to some extent on what happens with food inflation. “Whether the Fed cuts by 50 basis points or another 50 basis points, if food inflation shows no signs of easing in a durable manner, the central bank’s target of 4% inflation will become more difficult to achieve. Managing food inflation will be very critical for the RBI to cut rates,” Joshi said.