INDIA HAS NO WORRY FROM LATEST FED HIKE

CHINESE SLOWDOWN HAS TO BE MONITORED

 

By Anjan Roy

 

At long last the US Federal Reserve – America’s central bank—has raised the interest rates, albeit hardly. This is the first hike in interest rates by the US central bank in over a decade.

 

The US Fed rate hike has been by a very small margin – from zero to just about 0.25% to 0.5%. It was so gradual and soft that the rate hike did not cause the disruptions in the global financial markets that everyone expected from such a decision.

 

The first question here is how will it affect India? It should not, and this has been borne out by what happened in the day after the Fed rate hike. The stock market remained more or less flat. The exchange rate also remained stable. The fund managers did not immediately think of taking money out of India and that left the financial markets unruffled.

 

But then why such a question that the distant decision of the US central bank should matter so much for India.To appreciate this question, a bit of a background.

 

Following the 2008 global financial melt-down, the world economy had gone into a recession. To lift the economy, measures were needed. US, as the biggest economy in the world, had taken leading steps, cutting its interest rates in stages to zero. When even that measure was not giving the desired lift, it had launched an unconventional monetary measure, now known as the Quantitative Easing.

 

QE was simply pushing more money into US financial system to encourage overall demand and activity. In effect, what then had happened is a lot of the QE funds had flown from US to other countries in their stock and bond markets, resulting in some sort of a assets price inflation and strengthened exchange rates. The funds flow had also paid for the excess imports of countries over their export earnings. Recipient countries had become used to cheap funds from US.

 

Now before, the Fed had stopped QE. And on December 16, Fed raised its interest rate from zero to positive for the first time in a decade. This was long expected –almost for a year. Fed had had  alsogiven indication that rates might be raised again in course of the coming year. By doing this, what Fed is doing is bringing its unconventional monetary policy from an “abnormal” stance to a more “normal” stance. But then, why such an obvious and gradual shift in Fed’s monetary policy should create such a lot of expectation and fears about its impact on other countries.

 

This question is relevant  because of our experience when the immediate past chairman of the Fed, Ben Bernanke, had announced his decision to “taper” bond purchases by the US central bank.That had caused huge uproar in the financial markets across the world. It may be recalled at that time (May 2013) and in the subsequent months, the Indian rupee had depreciated from Rs50 to a dollar to over Rs60 to a dollar.

 

Tapering of bond purchases meant that lower funds will be available and as a result  part of the funds flowing to other countries could be pulled out and at least fresh flows restricted.

 

Known now as the “taper tantrums”, the string of events across the world showed the power of the dollar in the wake of the global financial crisis in 2008. The taper tantrums hit India hard in 2013 because India was exposed to vulnerability because of its dependence on overseas funds flow. India was then running an uncovered high current account deficit – of around $88 billion.  Fiscal deficit was high, inflation rising –almost everything wrong was rising.

 

Today India’s external deficit was minimal, under 2.5% of the GDP, we have a fairly comfortable foreign exchange reserve and inflation low. Oil prices are low, gold imports have plummeted (which was fiercely rising then). We do not depend abjectly on funds flow from to finance our imports and meeting external dues.

 

Many other currencies, including the Brazilian peso, South African rand and the Russian rouble had faced the same fate during the subsequent months after that announcement and volatility continued for year.

 

US Fed’s rate rise had ended one major uncertainty for the global economy. The inevitable has happened and all the financial markets have discounted this in this interconnected world.

 

But then, a new uncertainty has cropped up in between. China’s economic footprint has enormously increased since the days of global financial melt-down and the deepest source of volatility and uncertainty stems from that country.

 

During that period of uncertainty, the Chinese yuan remained rock strong and China made its tentative move to make the yuan the next reserve currency. China had extended yuan credit lines to a large number of countries for use during exchange rate volatility.

 

This time round, the Chinese yuan had however depreciated – although rather marginally. It depreciated by only one-tenth of 1%. But that hides more than it reveals. Because the Chinese authorities grossly intervene in the market to stabilise its currency.

 

Chinese authorities had depreciated yuan in August  and that created a stir among many other countries, since China had emerged as a major importer and countries have become somewhat dependent on their exports to China. Many countries, including China and Brazil and Argentina, had seen a spate of fluctuations in their financial markets.

 

That is a pointer to what are the fears now. From the uncertainty over Fed rates hike, the fear has moved to what the Chinese will be doing and how their economy was behaving on ground. China is admittedly slowing down. It even officially expects Chinese economy to grow much slower by 6.5% this year from over 7.5% target. But then, the fear is, maybe, China is slowing down much faster and possibly to a crisis level. (IPA Service)