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How does the International Market Affect the Indian Stock Market?

  • Feb 15, 2024

Retail investors should consider this connection to understand market movements. Economic data releases, policy shifts, and geopolitical developments can affect India, providing insights into anticipated market reactions.

This article will guide you on how understanding these dynamics can help investors and policy authorities respond prudently during times of change while benefiting during steady periods.

How Global Markets Influence Indian Equities?

The Indian stock market is not isolated and is intricately linked to global financial markets. Owing to India's growing integration with the global economy over the past three decades, developments worldwide have a bearing on domestic market sentiment and direction.

Understanding this interconnectedness holds significance for retail investors looking to analyse market movements beyond just domestic factors. It provides perspectives into navigating external risks that induce volatility episodes from time to time.

Significance of Foreign Institutional Flows

Foreign Institutional Investors (FIIs) occurred as key market participants significantly impacting Indian equities. They bring in substantial foreign capital that aids overall market liquidity and stability during normal times. However, any risk-off episode prompting capital flight also adversely impacts the market.

During 2021-2022, foreign investors pulled out over $30 billion from domestic equities, responding to monetary tightening in advanced economies. This FII selling induced elevated volatility, spurring a market correction. Historical evidence suggests that FII behaviour tends to be a key driver of market swings in India. Tracking their flows provides clues to analysts.

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Influence of Global Economic Indicators

As prominent stock market benchmarks worldwide tend to closely track the economic outlooks of respective countries, major global economic data releases significantly sway investor risk appetite and capital flows:

1.    U.S. Payroll Figures

Encouraging employment metrics revive rate hike fears, directing flows from emerging to developed markets.

2.    China Manufacturing Surveys 

Signalling either a rebound or slowing demand impacts commodity exporters' stocks.

3.    Eurozone Inflation Estimates

Prompting hawkish policy shifts impact trade flows significantly

Furthermore, any marked revisions in International Monetary Fund global growth forecasts also generate realignments in fund allocation. Understanding such sentiment transmission mechanisms assists investors in connecting the dots.

Correlations with International Indices

Evaluating the short and long-term correlation of bellwether domestic indices like NIFTY 50 with international benchmarks reveals fascinating insights:

  • Over 90% long-term correlation with MSCI Emerging Markets index - underscores classification status
  • 85% correlation with the S&P 500 - signifies the influence of global investment climate

Meanwhile, low early-stage correlation gradually picking up indicates improving future integration:

  • Nasdaq 100 - 34% to 62% over 5 years
  • FTSE 100 - 46% to 74% over 7 years

Analysing such index correlations enables anticipating the potential scale of external shock transmission across stages of the economic cycle.

Impacts of Global Commodity Price Shifts

India's current account balance and currency valuation remain sensitive to global commodity prices. Any spike-induced imported inflation flares market expectations for interest rate hikes - diminishing the present value of future corporate cash flows. Sectorally, price fluctuations flowing into earnings uncertainty induce volatility in oil & gas, metal and mining stocks.

However, global commodity booms support the profitability of domestic materials companies, having ricochet effects on banking, infrastructure, capital goods, and ancillary sector stocks based on value chain interlinkages. Understanding indirect connections aids broader analysis.

Influence of Monetary Policy Shifts

With extensively integrated financial markets, any policy shift by major central banks sparks a realignment in global capital flows through changes in the underlying risk-free rate used for discounting future cash flows: 

  • Fed rate hikes prompt equity sell-offs as risk-free rates rise, diminishing present values and spurring market corrections until sitting in a new equilibrium.
  • European Central Bank signalling quantitative tightening, leading debt-ridden emerging markets to face intensified borrowing costs and currency depreciation, impacting foreign flows.

These monetary policy signalling effects induce short-term turbulence as markets adjust to new fundamentals.

Spillovers from Geopolitical Events 

Escalations in global geopolitical tensions prompt intense risk reassessments by institutional investors related to specific countries or regions witnessing conflicts. However, capital shifts from emerging markets tend to be more indiscriminate during such risk-off episodes rather than distinguishing between directly and indirectly impacted economies.

For instance, while India had negligible direct trade ties with Russia, the Ukraine crisis triggered magnified volatility as large FII outflows from domestic equities reflected only general avoidance of emerging market exposure, given anxieties around rising oil prices and slowing global growth. Geopolitical events tend to have unintended spillovers.

Conclusion

Considering the influence of diverse global dynamics on domestic stocks assists retail investors in assessing inherent factors alongside external linkages. Tracing associative patterns further assists with proactive portfolio management aligned to evolving global realities. Maintaining an expanded analytical ambit looking outward while investing inward enriches perspectives for informed decisions.



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