Following the 25 basis point rate cut by the Fed on Thursday, the Dow Jones Industrial average shot up by 330 points, Nasdaq by 70 points and the FTSE by 128 points. On Friday, the Nikkie rose by 288 points and the Hang Seng soared by 806 points. Altogether, the US Fed has cut the interest rate by 50 basis points and the latest one came as a surprise to the markets.

While the equity markets respected the move positively, the first victim was the US dollar, which dipped against the yen. Besides, the Bank of England had also cut the interest rate by 25 basis pointsrecently. The benefits of a rate cut and a falling dollar will go in favour of the East Asian economies which have been reeling under the fear of recession and battered financial markets.

What will be the impact on the stock markets? It could at best be volatile in the short term, linked specifically to domestic stories like the first half corporate earnings and the US-64 scare, besides the credit policy due at the end of this month. The rupee is likely to remain stable for two reasons. One, the forex reserves are around $ 29 billion and the US dollar itself has weakened against international currencies in recent weeks.

In the medium-to-long term, the stock markets will depend to a great extent on the fresh allocation of funds by the foreign institutional investors. It is here that the chances of India losing out to other emerging markets (like the Phillipines or Thailand in Asia and other Latin American countries) may be greater. The size of the funds available for investment in the emerging marketscould be much larger for two reasons: one, the return on equity in the US is getting flatter and the possibility of funds moving away from stock markets cannot be ruled out; and two, early signs of recovery in Asian economies and attractive valuations prevailing in these countries.

One of the reasons why India may not get a larger share of the foreign funds is that in relative terms the FII withdrawal of funds from the country have been much smaller than what has been witnessed in other Asian countries.

Since the beginning of May, India has seen a net outflow of around $ 600 million. This is a around five to six per cent of the net cummulative investment of FIIs in the country. The net cummulative FII investment is a little over $ 8 billion today.

The sensex seems to be bottoming out around 2,800 points. This has been the case over the last three years. The recent pull-out of $ 78 million or Rs 333 crore by the FIIs was triggered by the US-64 scare when the sensex was around the 3,200-level. In thenext two to three months, the sensex could be seen moving within this band depending to larger extent on the inflows of FIIs. There is very little chance of FIIs pulling out funds at the current level.

On the contrary, the market may see fresh inflows as valuations are attractive considering the first half results that are being announced now. The discounting of the first half earnings could see the index reaching 3000-3100 level in the next one month or so. Once the market reaches this level, say a gain of 15 to 20 per cent, the downward correction will resume when FIIs close their game for the year as their December-end accounting nears. The outlook for the next three months is volatility.

In the short-term India will stand very little chance of getting any major gains from the reallocation of funds among various financial instruement following the interest rate cuts announced by the US.