Santosh Kumar Mohapatra
The US Federal Reserve Board raised benchmark interest rate by 25 basis points (0.25 per cent) December 14; it was the first in 2016 and the second since the end of the Great Recession of 2008. Though, the Federal Reserve had prognosticated four interest rate rises this year, it delivered only one.
This was part of the Fed’s long-awaited effort to normalise interest rates as the economy continues to recover.
Higher interest rates mean higher borrowing costs for individuals and businesses, and that usually means there’s less money to spend elsewhere. The announcement of the Federal Reserve to raise the fed funds rate 0.25 per cent had an immediate impact on prime loan rate, escalating them to 3.75 per cent from 3.5 per cent, mirroring the magnitude of the Fed’s increase.
But the US Federal Reserve’s decision of increase interest rate could not have come at a worse time for India, especially since the country is grappling with the ill-effects of demonetisation and is facing uncertain times.
But Chief Economic Adviser Arvind Subramanian has said that rate hike by the US Federal Reserve is in line with global expectations and its impact on India will be “very minimal” due to our strong macroeconomic conditions such as declining inflation, dwindling fiscal deficit and a robust external situation.
According to Economic Affairs Secretary Shaktikanta Das, this is the first hike in about a decade which signals a recovery in the US economy, end of uncertainty and accommodative outlook for the future which will help policymakers in emerging economies and enhance India’s exports, especially for the IT sector. Volatility in the Indian market should be reduced by this global development.
India is prepared to deal with the impact of the US Federal Reserve interest rate hike and the end of uncertainties will actually help policymakers in emerging economies.
But they are probably not telling the truth and may not have taken the damage done to economy by demonetisation into account. Elevated interest rates in the US will make capital more costly, and will affect Indian companies that were expecting funds at low interest from that country.
Any monetary policy changes in the US causes knee-jerk reaction in global economies including India. It will lead to outflow of capital in search of higher yields in the US treasury/bonds. Foreign Institutional Investors are already pulling money (around $2.5 bn) out the Indian equity markets.
This has come as another setback for the Indian economy which is grappling with a slowdown and the abrupt decline in jobs and economic activity following demonetisation. Several agencies, including the Reserve Bank of India, have already reduced their projections of growth for the country’s GDP.
The outflow of foreign capital will trigger depreciation of the rupee. This may make India more competitive in exports, but because of slowdown, India will not be able to take advantage of the situation. Being an importer of crude oil, a depreciating rupee will cause price rise and add pressure on inflation.
In fact, the tightening of money supply across the world may further force the RBI to hike rates or hold rates in future. This would result in a rise in the cost of borrowing for home buyers as well as real estate developers already hit by demonetisation.
When the Reserve Bank of India (RBI) decided to keep key policy rates unchanged in its monetary policy review December 7, it cited a likely rate hike by the US Federal Reserve as a reason for its caution. Hence, the impact of US interest rate hike may be enormous on India.
The author is an Orissa-based financial columnist.
