The US Federal Reserve increased interest rates on Wednesday after a gap of nearly a decade. While the event was widely anticipated -- Fed chair Janet Yellen hinted at a hike a fortnight ago -- the decision had made Asian markets jittery as foreign investors pulled money out in the run-up to the increase.
Although the Indian economy is better placed than many of its Asian counterparts, foreign investors had withdrawn funds from Indian equities over the past few weeks and the rupee tumbled to its lowest level in more than two years against the dollar.
With the Fed raising rates by a quarter percentage point, to a higher range of 0.25 to 0.50 per cent, will India now fare better or worse?
Positive for rupee, stocks
The hike will be positive for the rupee. While the domestic currency received a drubbing in recent months, falling below 67 against the dollar, it can breathe a sigh of relief. With foreign outflows likely moderating after the Fed hike, demand for dollars may decrease. This will stabilise the Indian currency.
Also, with India being better placed than most of its developing world counterparts, the rupee may not be as impacted as other emerging market currencies such as the Brazilian real.
“The rupee is likely to emerge as a gainer in the near term,” said Bansi Madhavani, analyst at ratings firm Ind-Ra. “It is likely to gain in today’s trading session and consolidate in the 66.3-66.6 a dollar range.”
The stock market may also see an upturn given the strong position of domestic inflows and more clarity on foreign fund flows. However, Indian equities are likely to experience more volatility in coming days.
The Bombay Stock Exchange’s benchmark Sensex rose on Wednesday just before the Fed hike and was trading 0.7 per cent higher on Thursday afternoon.
Impact on interest rates
Ind-Ra also highlighted a softening of yields on the 10-year government bonds to around 7.7 per cent with a downward bias. Lower yields on government bonds bode well for a decline in interest rates.
With the Fed rate hike out of the way and the Fed pointing towards a gradual change in rates going forward, the Reserve Bank of India will have one less thing to worry about and it can now concentrate more on domestic factors before looking to cut interest rates again.
The RBI has cut rates four times this year to boost growth but stood pat at its most recent monetary policy review earlier this month.
The pace of further rate hikes by the Fed will also be important for the Indian economy. If the Fed moves too fast on rates, it can weaken the rupee and may disrupt the pact of rate cuts by the RBI.
Is India in the clear?
“India is not immune to potential general emerging market jitters related to the Fed lift-off, but it is better placed than many of its peers for a number of reasons,” said Thomas Rookmaaker, director of sovereign ratings at global ratings firm Fitch.
He said that India’s external balances have significantly improved since mid-2013, with foreign exchange reserves rising by about $65 billion to $353 billion as of November 2015 and the current account deficit narrowing. Also, India is less dependent than several of its peers on commodity exports, and so hasn’t been hurt by the global rout in commodity prices.
Rookmaaker also said that only a small part of India’s sovereign debt is held by foreigners or is denominated in foreign currency. Moreover, favourable economic growth outlook makes India relatively attractive for foreign investors, he added.
Economic affairs secretary Shaktikanta Das tweeted that the end of uncertainty and accommodative outlook for the future will help policy makers in emerging economies. He added that the Fed's confidence about a recovery in the US economy is good news for India's exports, especially for the IT sector.
Chief economic adviser Arvind Subramanian said the rate hike will have minimal impact due to India’s strong macroeconomic conditions. "We are really well cushioned. Inflation is coming down, [the] fiscal deficit situation is very good, [and] external situation is also robust," he said, according to a PTI report.