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Tue, Aug 26 2014. 10 49 PM IST

What will be the impact of a US Fed rate hike on Indian

markets?
Going by the previous episodes, Indian markets have little to worry
The biggest external risk the markets are facing, although you
wouldnt really know it by looking at their elevated level, is that of
interest rate hikes by the US Federal Reserve. Reserve Bank of India
governor Raghuram Rajan has waxed lyrical about this risk, as
have the Bank for International Settlements and even the
International Monetary Fund.
Perhaps a look at previous episodes of interest rate raises in the US
might be useful. A recent research note on Asia strategy by BNP
Paribas does precisely that. It looks at earlier occasions when the
yield on the US 10-year treasury note went up and checks how it
affected Asian equities (see chart).

The biggest external risk the markets are facing, although

you wouldnt really know it by looking at their elevated level,
is that of interest rate hikes by the US Federal Reserve.
Photo: Mint

Consider 1993-94, when higher US rates shook emerging markets

and precipitated a crisis in Mexico, named the Tequila crisis. After
the initial scare, note that the MSCI Asia ex-Japan Index didnt do too
shabbily, rising 22.5%, while the Indian market did even better. And
this was despite a 2.5 percentage point hike in the US 10-year bond
yield over that short period.

Next, in 1998-2000, when the US 10-year treasury yield went up 2

percentage points, the Asian markets shrugged it off completely. This was the time of the infamous dot-com boom, so the S&P 500 index
went up 32.6%, but the Asian markets, which were recovering from the Asian crisis, did much better. The Indian market again performed
splendidly.
The period 2003-06 saw US 10-year treasury yields rise 1.8 percentage points. But this was the time of the great boom, which propelled the
MSCI India Index up a spectacular 216.9% over the period. Of course, the then Fed chairman Alan Greenspan took good care to ensure
that his policy of hiking policy rates in homeopathic doses kept the party going.
While the Fed didnt hike rates in 2012-13, US 10-year bond yields did move up by 1.5 percentage points during the year on liquidity
concernsthe period includes last years taper tantrum. This time, the S&P 500 went up 32.9% and MSCI Asia ex-Japan by a much lower
14%. The Indian market, as usual, outperformed other Asian peers, but didnt do as well as the US.
Going by the previous episodes, therefore, Indian markets have little to worry. BNP Paribas says the denouement after a Fed hike this time
will probably be much like the most recent 2012-13 episode. Note that US 10-year treasury yields are currently well below the level they
were at the end of 2013, reflecting continuing scepticism about growth. It also reflects the markets belief that Fed chairperson Janet
Yellen has neither the guts nor the inclination to withdraw what used to be quaintly called the punch bowl, but now is much more like crack
cocaine.
The BNP Paribas note adds that emerging market flows are not abating despite the rate scare. Rather investors are selling US and
European equity funds lately. That explains the markets lack of concern.
But can the massive doses of liquidity pumped in by central banks really be compared with the previous episodes? Has this ocean of
liquidity not led to mispricing of assets? Should yields on Spains 10-year government bonds really be lower than on US 10-year treasury
notes? In short, the question really is: can we escape a hangover even after such a massive binge?