ETMarkets Smart Talk | Higher US rates could accelerate capital flight from EMs, but India remains better insulated: Rajesh Palviya

The global interest-rate environment is once again becoming a key variable for emerging-market (EMs) equities. With US rates staying elevated and the 10-year Treasury yield moving above 5%, global investors have a more attractive alternative in the US fixed income, potentially putting pressure on capital flows towards emerging markets.

Rajesh Palviya, Head of Research at Axis Direct, believes another US rate hike could tighten global financial conditions, strengthen the dollar and accelerate capital outflows from emerging markets.

Higher global borrowing costs could also compress equity valuations, particularly for high-multiple growth stocks and debt-heavy companies.


However, Palviya says India is relatively better insulated, supported by comfortable forex reserves, fiscal consolidation and robust domestic liquidity. Steady DII and SIP flows can provide a cushion even as FPI selling weighs on benchmark indices, although sustained foreign outflows could continue to impact FPI-heavy sectors and stocks.

So, as investors track the Fed, US Treasury yields and the dollar, the key question is whether India's domestic liquidity and growth story can withstand another bout of global capital flight.

In this edition of ETMarkets Smart Talk, Rajesh Palviya explains what higher US rates could mean for Indian equities, the RBI, FPI flows and the sectors that may be better placed in a higher-rate environment. Edited Excerpts

Q) The Fed has raised rates by 25 bps, but markets were largely expecting it. What does this mean for Indian markets?

A) The market had largely discounted the 25 bps hike, leaving near-term impact on domestic equities relatively muted. The primary headwind stems from persistent foreign portfolio investor (FPI) outflows, driven by capital reallocations toward higher-yielding US debt. With India’s growth structural thesis intact, domestic institutional investors (DIIs) and robust SIP inflows continue to absorb FPI selling.

However, elevated US interest rates cap immediate valuation expansion for high-multiple sectors like IT and discretionary consumption. The focus shifts entirely to global yield trajectories and the RBI’s capacity to maintain rate differentials without triggering currency volatility.

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Q) For Indian equities, should investors be more concerned about the Fed’s rate decision itself or the resulting movement in US bond yields and the dollar?

A) Investors should focus primarily on US Treasury yields and the US Dollar Index (DXY) rather than the rate decision itself. The rate hike is a single input, but the 10-year US yield crossing 5% and a firm DXY directly dictate global capital flows.

When US yields rise alongside a stronger dollar, the risk-free rate of return in developed markets increases, compressing the equity risk premium (ERP) for emerging markets like India. Foreign flows remain heavily sensitive to these two macro variables, making yield dynamics the principal transmission channel for Indian equity valuations.

Q) If the Fed delivers another rate hike this year, what could this mean for global risk assets, emerging markets and capital flows?

A) Another rate hike in 2026 would tighten global financial conditions, strengthening the US dollar and accelerating capital flight from emerging markets (EMs). Higher global cost of capital compresses valuation multiples, particularly for growth equities and debt-laden corporates.

While India remains fundamentally better insulated than its EM peers, backed by comfortable forex reserves, strong fiscal consolidation, and robust domestic liquidity, continuous FPI selling will limit upside momentum for benchmark indices.

Secondary pressure would shift onto export-oriented and commodities sectors, favouring domestic-focused, defensive plays like pharmaceuticals, FMCG, and large-cap banks.

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Q) What does the Fed’s latest move mean for the RBI? Does India have enough room to pursue an independent monetary policy?

A) The Fed's policy stance reduces the RBI's manoeuvrability to cut rates, but India retains structural room to pursue an independent monetary policy. Driven by domestic CPI and food supply dynamics, the RBI can afford to prioritise growth while managing imported inflation through calibrated FX interventions.

However, widening rate differentials constrain aggressive monetary easing. To prevent sharp rupee depreciation and control imported inflation, the RBI will likely maintain a prolonged pause or deliver a measured policy response, keeping systemic liquidity tight to support currency stability without sacrificing economic growth.

Q) Does a higher-rate environment make US fixed income more compelling for global investors compared with the previous decade of ultra-low yields?

A) US fixed income now presents a compelling alternative to global risk assets. With 10-year Treasury yields trading above 5% and short-term yields remaining elevated, global institutional investors can lock in attractive real risk-free yields without equity volatility.

This environment alters global asset allocation models, encouraging fixed-income reallocation away from high-beta emerging market equities. Consequently, Indian equity markets must rely more heavily on superior earnings delivery and domestic retail flows to offset the reduced relative appeal of EM equities to global asset managers.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)