The US Federal Reserve held interest rates unchanged at the policy meeting that concluded on Wednesday. This concludes a round of key central bank meetings in September, wherein the European Central Bank (ECB), the Bank of Japan (BoJ) and the Fed all decided to maintain status quo. The nuances in their attitudes will be parsed carefully by the Reserve Bank of India (RBI) before its next policy meeting in early October when the RBI governor and the Monetary Policy Committee will consider the advisability of rate cuts. Global markets saw a relief rally after the Fed announcement. Global liquidity will remain very high so long as the Fed maintains status quo since every other major central bank favours high liquidity.
The BoJ, which has a negative interest rate, has added a long-term interest rate target designed to encourage inflation to its massive quantitative easing (QE) programme. The ECB also has a negative interest rate, as do other European central banks, such as the Swiss one. The ECB had indicated it might look to expand the scope of its own bond-buying. The Bank of England has prepared a QE strategy after the Brexit referendum. The Bank of China has slashed interest rates several times. The Fed, therefore, seemed out of step as it repeated earlier noises about raising the benchmark US dollar Fed Funds rate. Three of the 10-member Federal Open Markets Committee voted to raise the Fed Funds rate in September itself and the market consensus is that the Fed will hike it in December. The Fed says economic risks are "roughly balanced". Its Chairperson, Janet Yellen, said, "the economy has a little more room to run" and "we judged that the case for an increase has strengthened but decided for the time being to wait". Although traders are terrified of a potential US dollar rate hike, in practice, hikes are likely to be very gradual. The Fed expects US GDP growth to be only 1.8 per cent in 2016 and just two per cent in 2017 and 2018.
High liquidity and negative (or very low) rates across hard currency regimes should mean continued inflows to India's markets from foreign portfolio investors. FPIs have pumped the equivalent of Rs 45,866 crore into Indian equity and debt in this fiscal year. The flood may continue because, in comparative terms, India remains among the quickest-growing economies. But growth rates have not accelerated. India's GDP growth in 2016-17 is running at around the same levels as in 2015-16. Manufacturing remains slow, with the Index of Industrial Production showing nominal growth of only 0.2 per cent for the April-July 2016 period. Exports have suffered seven successive quarters of contraction. The rupee is substantially overvalued, going by RBI's own real effective exchange rate. Inflation has eased with food inflation declining after a good monsoon.
Slow growth, lower inflation and an overvalued currency all suggest that the RBI may be looking at a rate cut. But it must also contend with fears of rupee volatility as it reverses over $26 billion worth of FCNR swaps. The impending US presidential elections could also lead to market turmoil. By then, the next incumbent of the White House will be known and the Fed will, hopefully, clarify its stance. Even so, a rate cut by the RBI in December, if not in October, now looks very likely and markets are braced for the consequences of that.
