US Fed Hike and What it Means for India

With a hike in interest rates by the Federal Reserve, we examine how these developments impact Indian equities and and the USD-INR exchange rate

The Federal Open Market Commission (FOMC) colloquially though somewhat incorrectly referred the Federal Reserve decided, in its June 2017 meeting, to hike interest rates. Given that economics is a subject thriving on circularity, and the contusion of policies can undoubtedly be seen as a positive or as a negative; only time will tell whether the move is good, or whether it is bad, as most commentators may be predicting. TechSci Research experts have gone through the Federal Reserve statement and eked out the positive and negative elements that will define the Indian business sentiment and political situation given these recent (but not unexpected) developments.

Negative:  One school of thought suggests that the US economy is going through a soft patch. While unemployment is down to historically low levels, job creation is sluggish and the fear is that President Trump will not be able to sustain his pro-growth agenda. This stream of thought goes on to conclude that there is an expectations mismatch between the stock markets and what’s happening on the ground; essentially, that the stock markets have been unusually bullish on misguided cues which will have to be factored in sooner or later, resulting in an overlying bearish sentiment in the near future. What does this mean, then? In this view, savings rate will go up and some of the excess money in the system (in spite of the recent decline in inflation, the Fed Reserve has been unusually hawkish on this subject); with cost of borrowing increasing, mortgage rates will rise putting pressure on a huge number of homeowners.

Positive: The other school of thought suggests that the words of the Fed Reserve should be taken at face value. Historically low unemployment, a booming stock market and slowly rising consumer confidence levels suggest that the US economy has finally turned a corner, post the 2008 financial crisis. Given that this is the case, the Federal Reserve is slowly going back to its major function as an inflation-targeting institution as well as tightening the monetary policy. Tightening here refers to restricting consumer spending to suck the excess liquidity out of the system and thus lower inflation. This far, the Fed Reserve was hesitant to hike interest rates given that consumer spending was needed to boost the post-recession economy but now that this is no longer the case, the Reserve will continue to hike rates at the proper times in the future.

What This Means to India: The biggest impact India will face will be dependent on how the dollar behaves in the short run. Conventional wisdom suggests that a hike of this sort will make the dollar stronger, given that it becomes more ‘expensive’. If this is the case, there may be some slight incline in Indian exports. However, a weaker rupee will also make oil imports more expensive, and so it will be a mixed bag. The other factor is that the rate hike has improved the US bond yields. Given that the interest on US bonds has increased after the Fed announcement, there is a case to be made for an inflow of currency into the United States, give that US government bonds offer an attractive outlet to many investors, given their stability. India by comparison may become slightly less attractive, attracting lesser inflows for Indian equities. As mentioned before, economics is a subject dealing in circularity, and in this case as well, the attractiveness of US bonds depend on constant and consistent rate hikes by the Fed, and so, if more hikes are not forthcoming, it stands to reason that the foreign investment will come pouring back.