Fed Rates Hike: Impact on India

United States Federal Reserve (Fed) Chairwoman, Janet Yellen, announced a 25 basis points (bps) hike in the federal funds rate on December 16 and pledged a gradual pace of increase to more ‘normal’ levels. The number of Americans filing for unemployment benefits have reduced over the last five months. It was the 41st straight week that claims that unemployment remained below 300,000, a threshold associated with strong labor market conditions. That is the longest such run since the early 1970s. The other factor that contributed to rise in interest rate is the low inflation.

I. Introduction:

• U.S Federal Reserves has increased its benchmark federal fund rate for the first time in these Nine Years.

• This shift in policy rate may cause wobbling in Emerging Markets (EM), as they are more vulnerable than developed markets.

• Inflation in interests rates convey that US economy is doing very well, growth rate around 2-3%. So investors are more likely to bet on dollars and save their hedge cost.

II. Federal Reserve System

• The central banking system of the United States created on December 23, 1913.

• It is an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government.

• In 2015, the Federal Reserve made a profit of $100.2 billion and transferred $97.7 billion to the U.S. Treasury.

• Head-Quarters: Eccles Building, Washington D.C.

• Chair: Janet Yellen

A. Purposes of FED

• Manage Banking System
• Act as the central bank of the US
• Manage nation's money supply through monetary policy
• Maximum Employment
• Stable prices, including prevention of either inflation or deflation.

III. What and Why is rate hike?

• US FED rate hike refers to the raising (hike) of interest rates that the US FED is willing to provide to the banks of US for lending and borrowing activities.

• This in turn increases the interest rates of everything else in the US - of government bonds, of bank savings deposits by customers, of consumer loans etc.

• Similar to how when RBI raises or cuts interest rates in India, it affects the interest rates of our loans and deposits (FDs).

• US has seen its longest private sector hiring spurt. As per Fed the jobs market could spur a pickup in inflation and wages. In order to keep the inflation low, it is considering raising the cost of borrowing to keep the economy on an even keel.

IV. Impact on India

A. Impact on Economy:

• Dollar outflows could weaken the rupee, and hold the RBI back from cutting interest rates as that could lead to further outflows.
  
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  Dollar outflow could weaken Rupee and hold the RBI from cutting interest rates as that could lead to further outflows.

• With crude prices on a rise, a weak rupee will inflate the import bill and put pressure over government's finances.

• Already, demonetization and resulted currency shortage has dampened housing spending. This in turn could hurt firms sitting on vast unused capacities in consumption linked sectors.

B. Impact on Markets

• The rate hike is negative for emerging economies including India.

• It will increase the yields of US government bonds (they will offer better rates than before).

• This would prompt global money managers to shift a part of their money into the US government bonds which they usually put in emerging markets' equities.

C. Impact on Startups

• Shift the focus of VCs towards the US and move their major part of capital.

• More consolidation, shutdowns  and lowering of valuations of Indian startups in near future.

D. Impact on Companies

• For an exporter, a stronger dollar would mean higher earning in terms of rupees. But stiff demand and anemic demand in most export markets mean that exporters won't have too much to cheer about.

• Imports can turn expensive therby, squeezing the margins. This may lead to hike in prices of goods such as TVs and Cars.

• Also affect companies with foreign currency loans and repaying in dollars would be difficult.

E. Impact on Investments

• A stronger dollar would negatively impact gold prices.

• Equity could turn volatile for a short term but investments in quality companies would not be a very risky affair.

V. Conclusion

• Some experts argue that hike in fed rate may have limited effect on Indian economy. The fear of more such hikes in near future may well be a wrong speculation.

• Various schemes launched by government like Make in India and revised rates of Foreign Direct Investment(FDI) can cause inflow of foreign currency.

• Since India has dense consuming population and strategic Asian location, so it still seems better place for investment. An expected growth to be around 7.5-8.3% in 2015-16(World Bank report), means investors won't stay far from investing in India.