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Fed hikes rate: What India should watch out for

The US Federal Reserve on Wednesday raised interest rates, the first time in nearly a decade, aided by strong revival signs in the world’s largest economy.

business Updated: Dec 17, 2015 08:27 IST
Gaurav Choudhury
Chair of the US Federal Reserve Janet Yellen
Chair of the US Federal Reserve Janet Yellen(AFP)

The US Federal Reserve has raised its benchmark short-term interest rates by 0.25% after keeping it around zero since the start of the 2008 financial crisis.

The hike, announced after a meeting of the Fed’s top policy-making body on Wednesday was broadly along anticipated lines.

The move will have repercussions across the global financial system. Here is what India should watch out for.

1) Dollar flight

Higher interest rates will make the US markets more attractive for foreign investors. Funds will likely interpret the rate hike, albeit a small one, as a signal of the US central bank’s willingness to raise rates further in the coming months. This could prompt funds to move funds quickly from emerging markets such as India to the US in expectation of higher returns in the months to follow.

Read: Fed raises interest rates, cites ongoing US economic recovery

2) Currency blues

Currency values, pretty much like other commodities, are determined by demand and supply. The rupee’s value against the dollar will be determined primarily by whether dollars are coming in or going out of India. In case of a US rate hike, the demand for dollars to move away from India will rise weakening the rupee. Some analysts reckon that the rupee could fall to below 70 to a dollar. The rupee, closed at 66.73 to a dollar on Wednesday not very far from its record low of 68.85 it had touched on August 28, 2013

3) Shaky markets?

A copious outflow of foreign funds from India can adversely affect the equity markets as well. A sustained pull out by foreign institutional investors (FIIs) could temporarily bring down the benchmark indices—the 30-share BSE Sensex and the 50-Share NSE Nifty. Retail investors, however, should avoid panic selling and take only well-researched and informed decisions not guided by short-term volatility.

4) Costlier imports

A depreciating rupee will make imported goods costlier. So, expect computers, imported mobile phones, imported apples and chocolates among others to become costlier. It could also negate the gains from ultra-cheap crude oil. Cheap crude oil, currently at an 11-year low, has benefitted India that imports more than 75% of its oil needs. A weak rupee triggered by a dollar outflow, however, could offset this as it could increase the landed cost of oil shipments in local currency terms.

5) Costly education and travel

A weaker rupee implies students end up paying more to buy dollars to pay for fees, even though the fee in dollar terms remains unchanged. So, study loans might go up. Ditto for foreign travel. A weaker rupee implies vacationers end up paying more to buy dollars to pay for air tickets, hotel tariffs, shopping and other expenses. Even though the tariffs in dollar terms remain unchanged, a lower rupee could force people to buy more foreign exchange before they head out for the vacation.

6) No more EMI cuts?

The Reserve Bank of India (RBI) has cut its key lending rate—the repo rate-- by 1.25 percentage points since January 2015. A weaker currency, however, could dash hopes for more rate cuts. This is because, the RBI may be hesitant to cut interest rates to maintain India’s attractiveness as favoured destination for foreign funds and bring in dollars to stem the rupee’s fall.

7) No cheer for exports either

If you are exporter, a weaker rupee would mean your earnings in rupee terms will go up. But slowdown in EU, India’s biggest export markets, has forced orders to dry out. India’s merchandise exports shrank 24% in November, the 12th successive month of contraction, amid a global demand slowdown. India has to contend with rising competition from China, which is struggling to claw out of its worst slowdown in more than a decade hit by shrinking exports. China has devalued its currency--the yuan—to its lowest in nearly three years.

8) Costly debt

A dollar outflow and the resultant slide in the rupee’s value could hurt profitability of many companies. Companies that borrowed dollars from overseas banks will be the worst hit as repaying loans will become costlier, hurting bottom-lines.

9) Higher inflation

India’s retail inflation has crept up to a 14-month high of 5.41% in November driven by costlier food items. While retail inflation measured by the consumer price index (CPI) that captures changes in shop-end prices inched up from 5% in October, wholesale prices also mirrored a similar rising trend. A weaker rupee could fan inflation further. Imported raw material such a copper, aluminum and machinery will turn costly and squeeze profit margins. This may prompt companies to raise prices of consumer goods such as cars and televisions.

10) Focus on reforms

India is competing with other emerging countries to keep the flow of dollars intact. The focus will shift towards foreign direct investment (FDI) given that FIIs or hot money is expected to flow out quickly. India’s ability to remain at an attractive FDI destination will largely depend on the speed of reforms, removing red-tape and eliminating bureaucratic delays.