US Fed hike: Indian economy strong enough to absorb impact; equity markets stay upbeat

The Indian economy is strong enough to absorb the impact of the US Federal Reserve interest rate hike, the government said on Thursday. “Indian markets well placed to absorb US Fed rate hike. Gradual approach in future increases augurs well for emerging markets,” India’s Economic Affairs Secretary Shaktikanta Das said in a tweet, a day after the Fed hiked lending rates for the third time since the 2008 global financial crisis, with the American job market strengthening and the control of inflation rising toward its target. The Fed, on Wednesday, raised its key interest rate by 25 basis points (bps), making its third rate hike since the financial crisis and the second time in three months. In December 2016, the Fed increased its benchmark rate by 25 bps in the first rate hike in 2016 and just the second in a decade. The first was in December 2015. “In view of realised and expected labour market conditions and inflation, the central bank decided to raise the target range for the federal funds rate by 25 basis points to 0.75-1.0 per cent,” the Fed’s policy-making committee said in a statement released after its two-day meeting in Washington. The committee did not indicate any plans to accelerate the pace of monetary tightening. Further rate increases would only be “gradual”, the statement said. [caption id=“attachment_1384867” align=“alignleft” width=“380”]  Federal Reserve Chair Janet Yellen . AP[/caption] Indian equity markets reacted positively and the key indices opened higher on Thursday. The Sensitive Index (Sensex) of the BSE, which had closed at 29,398.11 points on Wednesday, opened higher at 29,482.83 points. Minutes into trading, it was quoting at 29,568.03 points, up by 169.12 points, or 0.53 per cent. At the National Stock Exchange (NSE), the broader 51-scrip Nifty, which had closed at 9,084.80 points, was quoting at 9,138.85 points, up by 54.05 points or 0.59 per cent. US Labour Department data on Friday showed that total non-farm payroll employment in the country increased by 235,000 in February. The unemployment rate was little changed at 4.7 per cent. Earlier in March, US Federal Reserve chairperson Janet Yellen had signalled that an interest rate hike in March’s monetary policy will likely be appropriate, if the economy progresses in line with official expectations. “With the job market strengthening and inflation rising toward our target, the median assessment of FOMC participants as of last December (2016) was that a cumulative 3/4 percentage point increase in the target range for the federal funds rate would likely be appropriate over the course of this year,” Yellen said in a speech at the Executives’ Club of Chicago. She also warned that waiting too long to raise interest rates could force the American central bank to act quickly in response to economic risks, which in turn could risk disrupting financial markets and pushing the economy into recession. According to analysts, a Fed rate hike of 25 bps could set off capital outflows from emerging market economies like India with large external funding needs and macro-economic imbalances, thereby increasing their vulnerability. “While the impact of the rate increase on the US economy will be negligible, emerging market economies with large external funding needs and macro-economic imbalances could be vulnerable to capital outflows,” Moody’s Investors Service has said in a report. “The most direct impact will be felt in those economies that have high external financing needs relative to their foreign exchange earnings and reserves,” the report said. The American agency said the spillover effect of the rate hike may manifest itself in different ways. “For instance, in some cases a pronounced currency depreciation could lead to higher inflation, which, along with the threat of sustained capital outflows, could force central banks to raise interest rates,” it said. “The Fed’s tightening could have negative spillovers for those with large external funding needs, high leverage, macroeconomic imbalances, or uncertainties around politics and policies,” it added. The Federal Reserve slashed rates to zero in 2008 in the wake the financial crisis and kept it at that level throughout the period of major economic slowdown that followed. India is currently seen as being better equipped than other emerging markets to ride the impact of higher US interest rates because of its stronger economic growth and impressive foreign exchange reserves of more than $300 billion.