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Fed Rate Hike-Implications for Indian Economy

... Ashish Bharati

The US Fed has finally bitten the bullet and as anticipated, has raised the rate by 25 basis points to 50 basis points now.

The question that immediately comes to our mind is that what this means for the Indian economy and the fund flow in and out of the country. My take is that the rate hike will not have substantive impact, though; one cannot deny its impact from a long term perspective.

Coming to the immediate impact, markets have already adjusted this rate hike as it has been in the offing for some time now and everyone expected this to happen. Over November 2015 and the first week of December 2015, equity outflow stood at around $1.7 billion, while debt outflow totaled $580 million. The Indian rupee has also seen a nervous pull down to a two-and-a-half year low of 67.10 to the dollar on Dec 14,

Further, Indian economy seems to be on a sound footing at this moment with Inflation (WPI) coming down and the fiscal deficit under reasonable levels. On the external front as well, current account deficit has been going down which is again a good sign. India is less dependent than other countries on commodity exports, and has thus not been negatively affected by the global rout in commodity prices. Further, only a small part of India’s sovereign debt is held by foreigners or is denominated in foreign currency.

Finally, the current Fed hike does not give very clear direction of the future direction as the US economy doesn’t seem to have recovered fully and giving any signs of over-heating to warrant further continued rate hikes.

This is so far as the short term is concerned, however, in the long-term the Indian policy makers need to be alert and take necessary steps to insulate India, if there were a continued hardening of the rates by the Fed. Though, this seems unlikely at this point of time given the fact that Wage growth and consumer inflation in the US still remain low. Retail inflation that the Fed uses is still below its official target. This combined with global deflationary trends may keep the rate from going up sharply.

Having said that, this and potential future rate hikes mark the end of the easy money environment and will put pressure on exchange rate of India(&other economies) which in turn may have a cascading effect on stock and bond markets. The good news is that, in the current environment of global slowdown, Indian economy has stood out with 7% plus growth rate. This makes India a preferred destination for global money. However, to insulate India, Govt. needs to push reforms, carry out banking sector reforms and maintain fiscal discipline, so that the economy is on a much more robust footing is able to withstand any reversal in the direction of capital flows.

 

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