Fed Rate Hike Decoding Impact on India and US

Economic Diplomacy

The immediate impact of the Fed rate hike will be felt on the consumer credit. The pinch will be felt particularly in credit card and auto loan section

Playing on the plausible lines, in December the US Federal Reserve ultimately raised the rate of interest for the first time in almost a decade. The Central Bank hiked interest rate by 0.25 basis points (bps). One basis point is one-hundredth of a percentage point. For market experts and economists, the latest move should transmit signals that further hikes are in wait, but all depends on how the global economy progresses forward from here.

Apart from the interest rate hike, the Fed also raised projection for the economic growth next year and it believes despite the rate hike the growth target will not be affected.

Interestingly, against the global expectation, equity and foreign exchange markets in emerging economies saw a bullish reaction to the hike. Till the point of action, it was widely assumed that the local bourses, especially in the emerging markets, will see investors pulling out their investments, eyeing the attractive US market.

However, it shouldn’t come as a revelation since substantiation from the past 10 hikes shows that stock markets reacted positively, at least on 8 out of 10 occasions, for almost all the countries under consideration.

The reaction from the Indian stock market has always been against the expected pessimistic reactions. After one month of the past 10 Fed rate hikes, the average stock market increased by 6.7 percent and the exchange rate depreciated marginally against the dollar. Market experts are again keeping fingers crossed and believe that since the macroeconomic situation is robust at least in the case of India, local markets will fare well.

From now on, as market experts suppose, further rate hikes will be gradual and take around a two-three year period to reach 2 percent. This means that the cost of money will still be low and not expensive as is expected in many quarters.

However, none of the indicators other than the unemployment rate have grown in the past few years. And even the inflation has come to a halt in the past 7 years despite effecting three rounds of Quantitative Easing (QE).

Effect on US

The immediate impact of the Fed rate hike will be felt on consumer credit. The pinch will be felt particularly in credit card and auto loan sections. In the past seven years, the median income of the American household has shrunk by about 1 percent and credit growth has increased at rate of 3.7 percent easily surpassing the growth in the US Gross Domestic Product (GDP).

Apprehensions are widely circulated in the global market that the recent hike by Fed encapsulates a partially defensive virtue. A section of experts considers that the latest move by the Central Bank is to counter recession. If rates stayed at near zero any longer, the economy could have easily slipped into recession.

Since the Fed has been under deflation since 2008, it is trying to avoid zero-bound trap by hiking the rates. It leaves adequate margin to cut rates in the future, which will help boost the economy in the coming days. In case the theory holds ground, the future may witness a few more rounds of rate hikes.

However, the objective of rate hikes may face a dampener since building distress in the junk bond market in the US can paralyse the global financial system. The situation appears all the more overcast since half of the junk bonds are exposed to the US oil sector, and already the crude prices are touching an 11-year low.

So far, a symmetric monetary policy was mainly influenced by sways in the market caused by expectations of a US rate hike. With the European Central Bank (ECB) indicating a new round of QE as well as Bank of Japan (BoJ) and Bank of England (BoE) not changing their policy stance, discrepancy in monetary policy is now an actuality.

Effect on India

Amid all this, India should stand a solid chance to gain from the positive market volatility in the approaching days, as it enjoys better macros compared to its peers.

Even before the Fed came up with the hike, the Reserve Bank of India (RBI) kept positively asserting in media that it is effectively prepared to face any kind of eventuality arising out of the rate hike. However, investors are unsure how much volatility will creep in, as a result of the rate increase.

Nevertheless, this time, the RBI will not be forced to resort to forceful control measures for bond yields to drop such as those witnessed in 2013. Back in 2013, the RBI restricted ability of banks to take positions in the currency market in order to halt fall of the rupee against the dollar, and hold bond yields from rising. Bond yields shot up in July and the rupee depreciated to its lifetime low of 68.85 a dollar in August 2013.

However, this time around the RBI wasn’t forced to intervene as in 2013. In fact, the day when the Fed announced its decision to hike the rate by 0.25 basis points (bps), stock markets in India bounced BSE’s 30-share Sensex rose 1.21 percent, or 309.41 points, to 25,803.78 points, while the National Stock Exchange (NSE)’s 50-share Nifty advanced 1.21 percent to 7,844.35 points. It was their biggest gain since November 19, 2015.

Also, NSE’s India VIX, or volatility index, which is a measure of near-term volatility in the market, dropped 15.02 percent, its steepest fall since 18 September, to 14.22, a level last seen on April 1, 2015 as traders heaved a sigh of relief that the ambiguity in the Fed’s course of action was over.

Likely impacts on India are as follow:

Foreign Portfolio Investments

• Equities: Equities form a substantial portion of foreign portfolio investments (FPIs) in India. There was an inflow of $1,641 million in October 2015 while outflow was recorded at $1,071 million in November 2015. An outflow of $724 million was recorded in the first half of December. This shows investors are cautious of the rate hike. Equity outflows are likely to moderate as uncertainty of the rate hike is eliminated and future movements would also depend on how the economy performs with corporate results holding the clue.

• Debt: Both the rise in the US rate and decline in the key rate in India by FY 75 bps in FY16 may have a negative impact on the debt flows. In addition, the debt limits have been almost used up in Government Securities (GSecs). Although, the corporate debt window is open to Foreign Institutional Investments (FIIs), there are limited funds flowing.

Rupee Movement

The Indian Rupee has been under stress of a forthcoming rate hike for sometime now. Just ahead of the Federal Open Marketing Committee (FOMC) meeting, the rupee reached a 2-year low level of INR 67.10. The prime reason behind depreciation is a high level of foreign capital outflow. The rupee will stabilise soon, as net forex reserves are fairly stable.

Inflation

Due to easing of commodity prices, especially a falling oil import bill, inflation has been in control. Increasing food inflation has been the main concern with a second consecutive season of a deficient monsoon having a bearing on the crop output. The weakening of rupee against the Greenback as a result of the US rate hike may reflect in the inflation numbers for subsequent months as imports become dearer. However, the impact shouldn’t be significant since the rupee has held its position after the announced rate hike.

Only the days ahead will notify how the Fed rate hike will affect the Indian economy – either positively or adversely.

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Author

Ashish Pandey

The writer is a freelance journalist based in New Delhi

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Diplomatist Magazine was launched in October of 1996 as the signature magazine of L.B. Associates (Pvt) Ltd, a contract publishing house based in Noida, a satellite town of New Delhi, India, the National Capital.

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