Given the belief that the US would start hiking interest rates as early as June, it is not surprising the Sensex rose by 357 points after news filtered through of the Fed’s dovish policy statement—it is a different matter that, with the market looking overbought, it later shed the gains and ended the day down 152 points. As a result of the stronger dollar, and weaker oil, and the impact of both in keeping inflation down—the stronger dollar has hit exports which, in turn, has tempered GDP growth—the Fed has lowered its estimates of both GDP growth as well as inflation. GDP estimates for 2015 have been lowered from 2.6-3% in December to 2.3-2.7% now and inflation from 1-1.6% to 0.6-0.8%. Inflation levels are not expected to touch the target of 2% in even 2016—the 2016 inflation projection is now 1.7-1.9% as compared to 1.7-2% earlier; actual inflation, it is important to keep in mind, has been running below the Fed’s projections for almost three years now. Which is why, the median target for the overnight rate, or the Fed funds rate, for the end of 2015 has been lowered from 1.125% at the end of December 2014 to 0.625% in the latest FOMC projection. Which is why, while the Fed has removed the word ‘patient’ from its terminology, Fed chairwoman Janet Yellen was quite clear that this didn’t mean the Fed would be impatient either.
For India, that means the central bank has more time to build up its forex reserves—these have risen from around 7 months of imports a year ago to around 11 months at the moment. To the extent the government is not able to attract more FII and FDI, adequate foreign exchange reserves are the only solution to a possible withdrawal of FII flows in response to higher US interest rates. Indeed, at the time when the rupee went into freefall in 2013, with just around 6 months of reserves, market players got the impression that RBI would not be able to defend the currency. Apart from giving the RBI more time, it also gives the government more time to get its act together. While the R20,000+crore tax demand on Cairn Energy Plc and Cairn India has once again shaken investor confidence, the lack of progress on the land acquisition Bill has underscored the government’s inability to get critical legislation through Parliament—the passage of the insurance Bill and the likely clearance of the coal and mines Bills, on the other hand, indicates the government is not totally helpless either. If you look at the 9 month period for which data is available, the NDA got $23.9 billion of FDI compared to $18.8 billion in the previous 9 months; in the case of FII, it got $39.41 billion as compared to $12.58 billion earlier. In other words, for now, a Fed interest rate hike is unlikely to hurt India as badly as one would have imagined a year ago.