How Bernanke's utterings affect the Sensex

We hear everyday on CNBC about how as a reaction to Fed action of raising interest rate the equity markets around the world are flundering. For the uninited this happens in the following way.

Though Indian markets as well as the other emerging markets have been responding in a positive way to the growh in the economy, their meteoric rise has been fuelled by the supply of FDI.

The rate of inflation is related to the supply of money in the market. With oil prices touching new highs, there is a real danger of inflation affecting people all over the world. One of the ways to keep inflation in check is by reducing the liquidity in the market ie reducing the flow of cash or easy money in the market. One of the ways of doing this is by increasing the interest rates on all lending.

This has a two fold effect. One, it reduced the amount of cash people are willing to borrow from banks to invest else where it also increased the amount of money going into fixed deposits and loans. Also, incurring new debt becomes expensive for corporations and they decrease their spending and hence growth. All of there have contributed to the outflow of hotmoney from the market leading to the crash that happened.

Now with BB, under playing the fears of inflation, it is hoped that there would be no futher increase in the nominal interest rates and we might see a resurgence of funds into emerging markets. This is what we may have seen during the last couple of days.

Also the fact that we bounced off the support level of 8800 we have may a stronger case for markets to gain some strength.

There have been some predictions of markets (BSE sensex) going up to 18000 in the next 2-3 years but for that cetiris peribus India would have to maintain its growth rate. of above 7 to 8 percent.