While domestic institutional investors have propped up the Indian market, foreign institutional investors have been on a selling spree for much of this year.
With US Federal Reserve Chair Janet Yellen communicating her intention to raise the interest rate by December this year, equity, currency and bond markets are likely to react on Monday.
While the rupee could fall against the dollar, bond yields are seen rising by a few basis points; there could be volatility in equity markets, too.
Yellen's statement and the US central bank's position on the interest rate, coming just a few days before the Reserve Bank of India's fourth bi-monthly monetary policy review on Tuesday, could determine the direction of the markets through this week.
"RBI will either cut the rate by 25 basis points or there will be no rate cut.
"The rupee will trade in the range of 65.80 to 66.70 a dollar, with a weakening bias," said Anindya Banerjee, currency analyst, Kotak Securities. The rupee had ended last week at 66.16 a dollar, against the Thursday close of 65.99.
The weakness was mainly because of month-end dollar demand from importers.
Yellen said the US central bank was on track to raise interest rates this year, even as she acknowledged that economic surprises could lead to a change in that plan.
Meanwhile, the yield on the 10-year benchmark bonds ended nearly flat on Friday, at 7.72 per cent.
If RBI Governor Raghuram Rajan cuts the interest rate by 25 basis points on Tuesday, bond traders expect the yield to fall by five basis points.
Equities are likely to see some sharp movements this week, against the backdrop of Yellen's statement and RBI's policy decision.
"Yellen's statement has almost guaranteed that the Fed will increase the rate in December. However, the market has already factored in a rate increase, so there should be little impact on sentiment," said Dalton Capital Advisors (India) Managing Director UR Bhat.
Besides, Bhat believes debt inflows into India might be affected, putting further pressure on the rupee.
On the impact that RBI's fourth bi-monthly monetary policy review might have on market sentiment, Bhat said he expected a rise for markets on Monday in anticipation of an interest rate cut.
However, he added, there could be a decline if the central bank decided not to lower the rate.
"A status quo on interest rates will be very disappointing for the market.
A 25-basis-point rate cut will be par for the course, while a surprise 50-bp cut could cheer things up," said Bhat.
While domestic institutional investors have propped up the Indian market, foreign institutional investors have been on a selling spree for much of this year.
So far in September, foreign institutional investors have sold shares worth about Rs 4,000 crore (Rs 40 billion), paring their year-to-date purchases to Rs 22,367 crore (Rs 223.67 billion).
"An interest rate increase in the US later this year will not be a surprise but our challenge is that emerging markets are running out of favour with foreign investors. That could lead to some more outflows," said Raamdeo Agrawal, joint managing director, Motilal Oswal Financial Services.
Since the start of 2015, the repo rate has been lowered by 75 basis points.
"This may be the last rate cut by RBI before a long pause. The bond market is factoring in a rate cut.
"It will be a big surprise for the market if RBI doesn't cut the rate this time," said a senior treasury official of a foreign bank who did not wish to be named.
MOVEMENTS AHEAD?
The drivers
US Federal Reserve Chair Janet Yellen's statement that the US central bank would likely raise the interest rate by December this year RBI's fourth bi-monthly monetary policy review on Tuesday where the central bank is expected to lower the rate by 25 bps
Current levels
Rupee: Closed at 66.70 a dollar on Friday, against 65.80 a day before
Bonds: Yield on the 10-year benchmark government bonds ended at 7.72% on Friday, nearly the same level as a day earlier
Sensex: Closed at 25,863.50 on Thursday, 40.51 points (0.16%) higher than the previous day
Nifty: Closed at 7,868.50 on Thursday, 22.55 points (0.29%) more than a day before
Image: A stock trader reacts. Photograph: Reuters
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