Oh…it’s the US interest rates again

It’s the season of interest rates again. For the first time since 2006, the Fed, headed by chair Ms. Janet Yellen,    is widely expected to increase its low interest rates by September, a move that would result in flight of capital from emerging markets across the world, and hence India as well. The fluctuations in the interest rates of developed economies of the West, to be exact – the USA, are well known to impact the flow of funds across the world. A change in monetary stance of the US would impact the emerging markets (particularly the BRICs nations) a great deal, who will then face an uphill task to navigate through the volatility infused in their economies by the former’s doing.

The headquarters Federal Reserve Bank on Constitution Avenue

In Washington, D.C., USA

Big Daddy USA!

So, why does a simple increase or decrease in the interest rates of a country on the opposite side of the globe send shockwaves to the nations residing happily in the East? Well the reasons are not that difficult to find. For one, the US is more than 25% of the world economy, standing at a mighty GDP of USD16 Tn. This simple figure is not just equivalent to 8 times the Indian economy, but also tantamount grand total of the economies of more than 150 nations forming the bottom of the GDP pyramid! Yes, it’s that massive an amount.

More than that, the West is represented by omnipresent rock bottom interest rates and inflation (almost 0 in many countries). As we witness deposit rates and inflation near 8% in India, it becomes difficult to comprehend that the same parameters are next to 0% over there. But that’s how it works, both the interest rates and inflation usually move hand in hand. The stability of the US bond markets along with an enviable economic history and solid financial architecture of these biggies help support low rate levels. With growth peaking and savings in abundance, there is less demand for capital and this subsequently dampens the investments opportunities for such countries. The low rates, however, position countries like ours a better place to put the bets.

After all, any sane individual would forego the nothing he gets on a dollar

to earn an 8 paisa a rupee in India.

It is easy said than done though. The institutional investors taking on mammoth positions in the markets have a lot at stake. For a modest return, they face the risk of capital loss. But as is said “risks trail rewards”

The rate hike would not only make the dollar more attractive but will

also help in strengthening its position as a global currency

The Emerging Market Context

Although the high interest rates lead to all kinds of troubles – from making the cost of borrowing expensive, to pinching the common man’s pocket through increase in EMI’s and ultimately creating a high priced market, we now understand that at the same time these high rates help our markets to attract global equity and debt flows – thus enhancing its liquidity and marketability.

The nations comprising the BRICs group

Let’s grab the concept swiftly

1) A rate hike, why now?

With US witnessing a better than expected growth and employment data, and healthy consumer demand, they find it suitable to go ahead with the decision. Put simply, a rate hike is an end to easy money.

2) Why it impacts India?

It is because the North American country is the only superpower in the world. It occupies a major chunk of global commerce and its decisions end up affecting the entire world. It runs a business monopoly in disguise. Moreover, the spread in the rates of the two countries leads to a pool of arbitrage opportunities often exploited by the “global analysts”.

3) Outlook on India

The increase in rates will make “hot money” (the short term cash flows) travel to the US in a blip. This would lead an increased demand for dollar, thus strengthening the greenback. A stronger dollar makes the rupee weaker. Moreover, with the possibility of another 200-300 basis points cut in the domestic interest rates this year (the RBI has already cut the benchmark rate by 50 bps) , it will further make the things exciting. But with our CAD and fiscal deficit largely under the lid, we are well poised to face the outflow of foreign monies.

The rupee will indeed face a downward pressure on account of heavy selling, but the increased trust in the rupee on back of strong fundamentals – the industry sentiment and fiscal environment can vouch for that, will help balance the things.

Dr. Rajan, RBI Governor and Ms.Christine Lagarde, Chief IMF at

an event organised by the RBI in Mumbai

It’s hard to diminish the impact of the hikes when the IMF Chief Ms.Christine Lagarde and the RBI Governor Mr.Raghuram Rajan warn in unison to better prepare for the contingency. However bad it may seem like, opportunities will abound a plenty.

With a super bull market in flow, a healthy correction would help the investors build up larger inventory of good quality stocks to benefit from – Capital gains is what we believe in.

 

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