fed

The much hyped Fed interest rate hike didn’t materialise. It all began in 2008, when Fed (Federal Reserve System) slashed the interest rate to zero and it even switched to quantitative easing programme to make credit availability cheaper for reviving the American economy from the subprime crisis. Since then the Fed’s balance sheet has inflated from $ 800 billion to $4.5 trillion. The Quantitative Easing (QE) programme was first implemented by the Bank of Japan in 2001. But this bold step taken by the Bank of Japan (BOJ) is often locked up on the wrong side of the history, as this brazen act from the part BOJ was not able to cure the ailing Japanese economy. In this respect Fed QE is often considered to be successful to a great extent in rejuvenating the American economy, even though it had many repercussions.

In 2013, when the then Fed Chairman Ben Bernanke hinted about an interest rate hike, generally considered as a revival sign of the American economy, it witnessed a series of turbulence especially in the emerging economies. India was also not immune from it. We were one among the fragile five economies, apart from Brazil, South Africa, Turkey and Indonesia. This was because there was a huge flow of capital onto the emerging economies, since the inception of QE, where the interest rates were comparatively higer that enabled the cheap credit from America to earn higher rate of return. When there was hint of what came to be known as ‘taper tantrum’ of Bernanke, there was a reverse flow of capital from these emerging economies. The result was a strong dollar and depreciating currencies of these emerging economies. The rupee has even collapsed to 68 per $ in 2013. The macroeconomic indicators of India were also not favourable for growth, with growth rate below 5 percent in 2013.

But the present scenario is different; we are in a much healthy stage as compared to 2013. The government was able to beat the arduous fiscal and revenue deficit target for the fiscal year 2014-15.India’s forex reserves now stands at $ 349 billion  compared to $ 275 billion  in 2013.The current account deficit has narrowed down and the inflation rate is also under control. Thanks to falling oil price that helped the government to cut down its import bill and subsidy bill. India will be able to gain more from plummeting oil price with the signing of Iran Nuclear Deal. The implementation of OROP is about to bring some fiscal strain and the ability of the government to meet the fiscal deficit target in 2016 FY is being questioned. But this is not a matter of present concern. Thus the robust macroeconomic indicators enabled us to come out of the fragile five. The IMF chief, Christine Lagarde during her visit to India early this year commented India a bright spot on a cloudy global horizon. With such a favourable background, we can’t expect that there will be huge capital outflow from the Indian economy. It will take time for the Fed to return to the normal path of interest rate, as only meagre hike in the interest rate is expected in the coming days. All this can act as a boon to our economy. But this is only one part of the story. The external commercial borrowing of the country has soared up from $ 57 billion in 2007 to $ 182 billion towards the end of March 2015.  In terms of total external debt of the country, government accounts for less than one-fifth of the total share. These developments bestow a scary picture to the Indian companies, as they will be the most affected with the Fed interest hike. Fed interest rate hike will make dollar stronger that will put strain on the Indian companies for repaying their loans or paying interest on the loans.

 In the global scenario, Yuan devaluation and slow pace of demand growth in China, is leading to a further fall in crude oil and commodity prices. US being a major importer from China will be facing a deflationary tendency. Yuan devaluation is also forcing other Asian economies to devalue their currency to make their exports cheaper thus widening its trade deficit with Washington. It is becoming more difficult for the Fed to achieve its inflation target of 2 percent. Fed is expecting modest growth rate of GDP and much more improvement in labour market that will help in achieving the targeted unemployment rate. The domestic spending also seems to be robust, but achieving the inflation target of 2 percent still remains a problem.

 The Chinese stock market crash and Yuan devaluation has created turmoil in the world economy. In such a disturbing atmosphere, rate hike from the part of the Fed could have pushed the world economy into other crisis. By maintaining the interest rate at the current level, Fed has acted according to the need of the hour.

* The Author is Research Assistant at CPPR. Views are personal

Deepthi Mary Mathew
Deepthi Mary Mathew
Deepthi Mary Mathew is Senior Research Associate at the CPPR Centre for Comparative Studies. She has an MA in Economics from the University of Kerala and is also a PhD scholar at the Gokhale Institute of Economics. She can be contacted by email at deepthi@cppr.in or on Twitter @DeepthiMMathew