The prospect of a rate hike by Fed in its next FOMC – Federal Open Market Committee meeting to be held on 17th September at Washington DC is most likely, after the July job reports have indicated a robust growth. The Federal Reserve was expected to raise the Fed Funds rate by 25 bsp or basis points at the FOMC meeting on 28th July. However it did not, since the financial markets were yet to attain stability after Brexit.
Once the Fed raises the Fed Funds rate, it shall probably go up by 0.25 per cent at first and later on rise not beyond 2 per cent, since inflation is no more a threat. Turbulence might be felt in emerging markets like South Africa, India, Turkey Brazil, etc. where the local currencies will be weakened against the dollar. Now, there is possibility of knee-jerk reactions amongst the domestic traders and investors to begin with, followed by a dip in the Sensex and the value of rupee, as trade commences in domestic markets on Friday.
What happens to the Indian rupee if the Fed hikes rates?
If the Fed hikes rates, a few of the foreign investors are anticipated to book profit of their Indian holdings of bonds and shares. They might send home funds back to the US, where buying high interest rate bearing bonds shall be attractive. Also, they might offload masala bonds over US bonds. Selling by foreign investors leaves a great impact on Nifty and Sensex since they own shares in the blue chip segment, which comprises close to 25 per cent of the BSE, as per a recent report.
The Fed has spoken about raising rates for atleast a year. In response, we expect the value of dollar to rise. Further, strengthening of the US dollar shall hurt American exports more and slower their economic growth and shall create lower import prices, thereby reducing inflation.
Fed shall definitely raise interest rates to search a way out of a possible liquidity trap while the same in India shall mean a weaker rupee culminating into a fat import bill. India is a trade deficit country and the outflow in the form of debt and equity selling can put pressure on the Indian rupee. Also, India is already importing 80 per cent of oil to fulfill its fuel needs. India’s CPI or consumer price index has its major component as fuel and if the country’s import bill rises, it is feared inflation rate might also gallop up. Now, the Indian rupee could hit a low of 66 to 66.46 as against 66.73. Earlier in August, it had shed 4 per cent since August to 66.46 from 64.13 already and had rebound after correction.
What’s happening in India?
India doesn’t have a fixed exchange rate anymore. Rupee’s international value is determined in the foreign exchange market. The RBI intervenes whenever there is volatility. The Narendra Modi government is considering to setting up a committee to determine the fair value of the Indian currency. This is not a feasible idea as times have drastically changed and we are not living in 1991, and definitely not in 1966.
Rupee devaluation kick-off in 1966:
For the first two decades after independence, India had a constant peg against dollar at Rs.4.75/dollar. However, 4th June, 1966, saw the first major devaluation. India was in a wobbly, unsteady state as it had just fought 2 major wars with Pakistan and China and had a swapping of 3 Prime Ministers (Nehru, Shastri, Indira) in a span of 3 years after 17 long years of one man rule. This was followed by a major drought which shook the country to the roots. In the 1966 Budget the Indian government announced a massive depreciation of 57 per cent of the rupee overnight from Rs.4.75/dollar to Rs.7.5/dollar.
Energy crisis and gold sky-high prices of 1980s:
From 1966 to the year 1980, rupee maintained status quo. The year 1979 brought along with it theenergy crisis and gold’s sky-high prices in early 1980s which left the nation cornered since oil and gold were historically India’s primary imports. Indian rupee began to decline gradually. From about 7.85/dollar in 1980 it slumped to about 17/dollar by 1991.
The nightmare of July 1991:
India was hit by another major crisis in July 1991. In layman terms, rupee was overnight devalued by another 50 per cent from about 17/dollar to about 25/dollar.
Liberalization in 1993 followed by the Asian crisis of 1997:
Indian Finance Minister allowed rupee to float a bit freely in the 1993 liberalization. The rupee was set free to be traded by traders without a compelled peg. Since the government was no longer controlling the prices fully, rupee slid to 35/dollar by 1997.
The year 1997 was no boon either as the Asian continent was hit by a financial crisis. Investors were quitting Asia enmasse which devalued rupee further from 35/dollar to 39/dollar.
Pokhran- II bombarded Indian rupee:
In 1998, Indian Prime Minster announced the nuclear testing (Pokhran-II). Immediately countries like US, Japan and others imposed sanctions on India, limiting investments. In a mere span of two months, rupee tanked to 43/dollar and in 2002 reached at Rs.48/dollar.
The rainbow of hope:
All of a sudden light was seen at the end of the cave for 7 years from 2000 to 2007. Rupee started recovering and began moving up and reached about 39/dollar by the year 2007.
Shit hits the fan:
Happiness sadly came with an expiry date and “shit hit the fan”- the financial crisis of 2007–08. This caused the investors to retreat from all emerging markets, including India which dragged the rupee from 39/dollar to 51/dollar by March 2009. In the next 2 years however, rupee recovered a great deal due to economic optimism and rebound in the US markets.
The European sovereign-debt crisis:
Jinxed as rupee was, European sovereign-debt crisis hit the world in 2011. Another reason was Indian government’s budget positions getting worse because of profligate overspending. The rupee doomed from 44/dollar in August 2011 to about 56/dollar by June 2012.
Conclusion:
The effect of a rate hike in the US on India shall be confined due to strong fundamentals as a tidy repo rate structure, inflation targeting and airtight money control by the RBI. The novel tax reform is a big revenue boost and a novel engine of growth to act as a firewall against all possible global impacts such as Brexit, Fed rate hikes, oil prices and so on and so forth.
We just have to now wait and watch how the Fed’s announcement impacts the Dalal Street. Something or the other will keep popping up on the horizon like Fed rate hike, devaluation by China, oil prices. But the only ray of hope is that India will strike its own balance under the prevailing global economic conditions.
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