What will happen to stocks if the RBI raises rate hikes?

In India, the Reserve Bank of India (RBI) is tasked with the duty of keeping the Indian economy running as smoothly as possible by the Central Government. This means if the RBI believes the economy is underperforming, it can cut the repo rate, which makes borrowing money cheaper for individuals and businesses. Consequently, raising stock prices up and rewarding investors with better returns. The first months of the Covid-19 crisis are a good example of how this dynamic works. When the pandemic hit, there was a massive and rapid decline in economic activity, which saw the stock market drop to historic lows. To combat the decline, the RBI slashed rates as low as they could, and the economy and stocks were able to recover. However, have you ever wondered what happens when the RBI raises interest rates?

RBI And Interest Rate Hikes

During periods of high inflation or when asset bubbles get out of hand, the RBI raises interest rates to cool things off, which has a ripple effect on the entire economy. This means mortgages, car loans, and business loans become more expensive, thus slowing down cash flows. And this can lead businesses to amend or pause growth plans. However, in the stock market, higher rates can incentivize investors to sell assets and to take profits, especially in times like now when there have been a few years of double-digit percentage returns on stocks. Such decisions lead to lower stock prices – individually, at least if not across major market sectors. Also, if interest rates rise high enough, borrowing savings instruments like savings accounts or fixed deposits might look more attractive to some conservative investors.

How Stock Markets Are Impacted When Interest Rates Rise

The Indian stock market offers investors an opportunity to trade financial instruments such as shares, bonds, and derivatives. Specialized knowledge is required to trade these instruments successfully, including the use of charts to analyze and predict price movements based on support and resistance indicator, trendlines, etc.

There isn’t much correlation between rising rates and falling markets when you analyze the Indian stock market. A recent analysis by the Indian stock market of the Nifty 50 stocks during nine rate hike cycles found that stock market indexes declined only during three periods. The Nifty 50 saw a median increase across all eight cycles of 24.6% when factored together.

Dynamics Behind Rate Hikes And Stock Performance

When you are trying to determine which way the market may move, you need to be aware that the rate hikes do not hurt everyone equally. They can help certain sectors such as financial stocks. For example, if you are in the business of lending money, higher rates mean higher margins. On the other hand, rising rates tend to hurt growth stocks like tech startups since investors tend to look for stable companies, like commodities, indices’ stalwarts, and established tech firms in uncertain markets.

The logic is simple; these companies tend to pay dividends which ensures some growth even if the share price drops. High growth companies usually put their cash into expanding the business, and they tend to churn through cash, which means high borrowing costs can compromise their growth. It’s the reason why difficult markets can favor selective investors, sometimes called “stock pickers” – who happen to guess the right companies and industries to invest in as market conditions change. But this exercise isn’t as simple as you might think. Even professionals can find timing the market daunting since you are not only contending with any actions the RBI makes but also those of other investors as well. Many of them have already priced rate hikes into their trading calculations.

However, as an investor, there is no need to panic. While the RBI overnight lending rate matters, it is hardly the only thing impacting stock market returns. This is why experts recommend investors hold diversified portfolios of large index funds. This way, you already have exposure to short-term winners, even if it means you also hold some losers, and this helps position you as a winner in the long term.

Subscribe to our newsletter
Subscribe to our newsletter
Sign up here to get the latest news delivered directly to your inbox.
You can unsubscribe at any time