Bringing the curtains down on an era of near-zero
interest rates, the US Federal Reserve finally raised its key benchmark rate by
25 basis points last week, ending a prolonged period of uncertainty in global
markets. While the Fed’s decision was very much on expected lines, it may cause
some repercussions on emerging markets which will become relatively less
attractive in the wake of higher interest rates in the US. Further, the Fed’s
verdict will provide a further fuel to the dollar rally which may cause more
pain for dollar-denominated commodities, worsening a global commodity rout,
threatening to hurt EM capital flows. But, India, blessed with superior
macro-economic fundamentals, compared with EM peers is unlikely to be much
affected by the start of the Fed’s policy tightening cycle. Let’s see why?
With a forex reserves kitty of over USD 350 billion,
India has plenty of ammunition to deal with any potential volatility in global
capital flows on account of higher US interest rates. Vast improvement on the
current account front means that India’s external balances are strong, lending
it less vulnerable to global shocks.
India, which doesn’t rely on commodity exports like its
BRICS peers won’t be adversely affected by an ongoing commodity rout.
With a very small part of India’s sovereign debt held by
foreigners or denominated in foreign currency, a strengthening dollar is
unlikely to affect India much. Contrarily, a stronger dollar vis-à-vis rupee
could boost the competitiveness of India’s exports which shrank for a twelfth
month on the trot in November.
Moreover, India, being the world’s fastest growing major
economy with growth clipping well above 7 per cent will continue to remain an
attractive destination for foreign investors at a time when China is headed for
the weakest growth in 25 years, and Brazil & Russia are in steep recession.
At the same time, a progress on key reforms such as GST which faces the threat
of delayed implementation amidst political roadblocks is critical for putting
Asia’s third biggest economy on the path to attaining double-digit growth, and
consolidating the country’s growing investment prowess.
Even as the Fed raised the target of its federal
funds rate to 0.25 per cent to 0.5 per cent, from 0 to 0.25 per cent
previously, it signaled a “gradual” pace of tightening, a sign that monetary
policy in the world’s biggest economy will continue to remain fairly
accommodative despite the first hike in interest rates in almost a decade. A
measured pace of US policy tightening, coupled with record stimulus from Bank
of Japan & the European Central Bank (ECB) and expectations of further
monetary easing in China may prompt foreign funds to continue flocking to India
amidst lack of any challenging alternatives elsewhere.
