New Delhi [India], September 29 (ANI): The monetary policy tightening in the US and the subsequent strength in the dollar could continue to be a source of volatility for Indian equities in the coming months, due to their negative effect on earnings and balance of payments, said Morgan Stanley.

"Indian equity return correlations with the rest of the world have risen in recent weeks and could remain elevated for now," a Morgan Stanley's report titled "India Equity Strategy: Events to Watch: 4Q22 - Volatility, Correlations and Potential Big Moves", authored by Ridham Desai, Sheela Rathi, Nayant Parekh, Apurva Jain, said.

Indian equities entered bear markets when the US slipped into recession, the report said.

"We have been worried about profit margins, and this remains a point of focus as we head into another earnings season. Our F2023 earnings estimates are still 5 per cent below the consensus average, even with consensus lowering earnings estimates of late. We see further risk to earnings from a slowdown in global growth in 2023," it said adding that it believes one way to offset such a risk is by improving domestic capital expenditure.

Eyes will also be on foreign portfolio investors' funding trajectory.

"FPI ownership is at multi-year lows and persistent selling since mid-2021 (except for the past few weeks) implies that as a cohort it has missed out on one of the best performing large equity markets in the world," it said.

Foreign portfolio investors (FPIs), though, have continued to remain net buyers in Indian equity markets for three consecutive months now, but the overall investments were weak.

Foreign portfolio investors (FPIs) have been selling equities in the Indian markets due to various reasons, including tightening of monetary policy in advanced economies, rising demand for dollar-denominated commodities, and strength in the US dollar index, which triggered a consistent outflow of funds from Indian markets. Investors typically prefer stable markets in times of high volatility.

Further, consistent depreciation of the rupee and depleting Indian foreign exchange reserves also had a bearing on the weak foreign investment sentiments. The forex reserves have dropped by over USD 80 billion since the escalation of the Russia-Ukraine tensions into war earlier this year.

For the record, FPIs have pulled out Rs 162,819 crore worth of equity assets in 2022 on a cumulative basis, NSDL data showed.

"The draining of foreign exchange reserves to curb currency volatility could be of greater significance if the BoP comes under more pressure," Morgan Stanley said.

On interest rates in India, it believes the RBI is likely to stay behind the US Federal Reserve, given India's improved macro stability. (ANI)