Why India need not fret over Fed’s rate hike move?

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.