Rates will rise fast, India needs to ready itself
During her first outing as Fed chairperson in March, Janet Yellen spooked markets when she diverted from the script and said the Fed would start hiking interest rates six months after it wound down the bond-purchase programme—that it, by around April or May next year. Several outings later, and a lot more Greenspaneque, as one commentator put it, Yellen didn’t spook the markets this time around, but indicated pretty much the same thing. While the Fed’s statement was dovish according to some since it said interest rates would be kept constant for a ‘considerable time’, the dots—the beliefs of Fed members on the time interest rates will rise are shown as dots in the graphic the Fed releases—indicate interest rates will be raised by May or June and, by the end of 2015, the Fed funds rate could be around 1.5% as compared to near zero right now. By all accounts that’s a pretty steep trajectory. If markets have remained relatively calm across the world—the Sensex rose 1.8%—it is because they have probably factored this in, and since the hikes will be data dependent, the Fed can just as easily get it wrong. As compared to even the June meeting, where the US 2015 GDP was estimated at 3-3.2%, the September forecast is a milder 2.6-3%; also the inflation forecast of 1.6-1.9% for 2015 is well below the Fed’s 2% target.
In India’s case, the fear is that the record FII debt flows of $18.7 billion till September—the highest in the last decade—could get affected. Which is why, at the G20 deputies meeting, India’s finance secretary Arvind Mayaram repeated the plea of coordinated action to deal with the exit from QE—India, though, didn’t complain about the benefits of it being introduced. He asked for the IMF to analyse the likely impact of the Fed’s actions and to examine whether precautionary swap lines could be made available to various countries. While the IMF already has such no-stigma lines of credit, India doesn’t qualify under the Flexible Credit Line which is meant for stronger economies. It does qualify under the Precautionary and Liquidity Line and could get $22-44 billion under this—250-500% of India’s IMF quota—but this requires agreeing to some conditionalities on sticking to deficit targets. It is doubtful, though, whether India would ever go to the IMF given this facility was available a year ago when the rupee looked like it was in free-fall—indeed, during this period, India doubled its precautionary swap facility with Japan to $50 billion. So, while RBI needs to continually buy dollars to build a credible defence against an attack on the rupee in the event of funds moving out, the government needs to do its best to convince investors India is a good place to invest in. As a first step, that means ensuring the investments promised by Japan and China start coming in sectors like railways and in new cities; it means coming up with a credible gas pricing policy by the end of the month; it means releasing telecom spectrum quickly, and not challenging the TDSAT’s 3G order ... The government’s first 3 months have seen a reasonable start, the next 6 have to build upon this in a more convincing manner.