Will the Fed rate hike be another shock after demonetisationIJ There are fears that, if the US economy improves and the Fed announces two more rate hikes in the next 12 months, they can impact investments in India
The US Federal Reserve rate hike of 0.25 per cent is likely to have an impact on the Indian economy, with increased outflow of foreign portfolio and institutional investors. It may also lead in the course of time to a rise in rates in India. The Reserve Bank of India kept it stagnant in its monetary policy some days ago, as it wanted to observe the US Fed move.
The outflow of foreign portfolio investment has already topped Rs10,700 crore in November in anticipation of the US rate hike. This is the worst ever data available since 2002. It has triggered a sell-off in stocks of companies with high FII holdings.
It reflects a strengthening US economy that is likely to make the emerging markets vulnerable to volatile capital outflows, international rating agency, Moody’s says.
The US economy, Moody’s observes, should continue to expand through 2018, and emerging markets exporters will benefit if US growth translates into higher import demand.
In other words, India may see a rise in outflows, but as the US economy improves, India can expect some rise in exports provided the Donald Trump regime allows such imports.
However, a signal from the US Fed will ultimately lead to subsequent rate hikes. A series of hikes in interest rates in the US over a period of time will raise the borrowing cost for carry trade (borrow from US and invest in India), and thereby reduce their risk-adjusted return in India.
On the other hand, the Reserve Bank of India has embarked on cutting interest rates, and has cut repo rates twice by 25 basis points each. A cut in India and a hike in US further reduce their risk-adjusted return. Experts also say that this may make US bonds more lucrative.
So, would it give another shock after demonetisationIJ It is not necessary but there are apprehensions that, if the US economy improves and the Fed announces two more rate hikes in the next 12 months, the moves can impact investments in India. Some of the promised foreign investments may either be delayed or not come. Some may be revised downwards.
It is too early to predict its impact on the overall growth projections. It has led the rupee prone to more shocks. The rupee weakened by 43 paise against the dollar as gained against global currencies. It may slip further as demonetisation has made the economy shaky. Besides, foreign fund outflows also kept pressure on the rupee.
This makes imports, particularly petroleum crude, expensive. It may have an inflationary pressure on the economy as hike in petroleum prices would lead to higher transportation costs. It may have a minor impact also on the country’s forex reserves particularly, as there is a thaw in exports amid global uncertainties.
Exports were also hit owing to a cash crunch, says Commerce Secretary Rita Teaotia. But despite the problem, exports are expected to reach $280 billion by March, 2017, as against $261.13 billion in 2015-16, though some fall in target is likely.
The US rate hike and industrial production data for October 2016 — the last point before demonetisation — released on December 9, showed that overall industrial output contracted by 1.9 per cent. The fall over September was steeper at 6.3 per cent. The index (IIP) has grown by minus 0.3 per cent this year so far (April-October), compared to a corresponding 4.8 per cent growth last year. This shows how weak industrial activity was even without demonetisation.
Growth in consumer goods, although positive at 1.2 per cent in the year so far, was weaker than the last year. And capital goods output growth was minus 22 per cent in the period (minus 26 per cent in October) relative to a decent nine per cent growth in April-October 2015.
Production actually dropped in April-October across mining (minus 0.2 percent against 2.2 per cent last year) and manufacturing (minus one per cent as against five per cent growth in April-October 2015), with only the electricity segment showing positive: 4.6 per cent growth.
Demonetisation may hurt demand, with consumer goods being the worst affected. Cement sale volumes halved in November. Developers are pruning overall costs, including staff, to economise on cash and sustain bottom lines. Ripple effects will be felt in steel and other inputs as well. Automobile sales in November were 5.48 per cent lower — the slide is expected to accelerate in coming months as sagging retail sales feed back to manufacturers who may even cut output in next round. Consumer goods’ firms, whose sales volumes either fell or grew feebly in September quarter, will also get impacted.
The credit growth fall by over Rs65,000 crore (November 11 to 25) indicates weak demand and production. The total fall may exceed one lakh crore rupees. The impact of demonetisation on industry may be indicated from the December data, which arrives in February 2017.
The Government is treading on a difficult path. The daily-wagers, including MGNREGA labourers, are either facing job losses or severe cash crunch. The migrants are returning home. The cash crunch is hitting industry, farm sector,mandis, vegetable, onion and potato prices. It has also caused sharp rise in wheat prices as the market sees production fall.
The fall in retail inflation indicates that the consumer is unable to make purchases. Even credit-card servers are collapsing owing to excessive load. Steps are needed to check rise in prices as the market comes out of shock may be by mid-January in the wake of interest rates hike by US Fed Reserve and oil price hike.
The Government has to carve out the Union Budget carefully to maintain its popular support, create demand and jobs. It should resist the temptation of increasing rail fares or reduce so-called Rs21,391 crore ‘subsidies’. Another white paper on rail accounting processes of two decades, should also be considered.
People are expecting a cut in income tax rates, doing away with tax deduction at source on bank deposits, decision on floor deposit rate of nine per cent and other necessary real reforms for ease of business and job growth. Tax reforms are needed to win popular support. The Government is faced with challenges.
(The writer is a senior journalist)