New York: Federal Reserve Chair Janet Yellen is not about rude surprises. She raised US interest rates on Wednesday by 0.25 percent in a widely anticipated move. An astute risk manager, Yellen took great pains to eradicate any confusion about the rate hike, giving skittish markets around the world from India to the US plenty of time to price it in.
In June 2013, emerging markets like India were roiled after the Fed offered a timeline for winding down its bond-buying program. The first signs of US monetary policy tightening sent chills, drawing billions back from countries like India, Brazil and China to US assets with investors seeking the relative safety of U.S. equities.
The prospect of US monetary policy tightening was so frightening that between May and August 2013, the rupee lost more than a quarter of its value, as bond and equity markets tanked. Today, India growing at a 7.4 percent clip looks on firmer ground and in good nick to tackle external pressure.
“Volatility and market swings are possible, but I don’t see the prospect of as much turbulence this time. The Fed has acted largely within market expectations,” Sean Levinson of Cassel Capital Management told Firstpost.
On Wednesday, during a press conference after the Fed decision was announced Yellen assured markets that the Fed will move in “prudent” and “gradual” steps. The prospect of gradual rises could bring some stability to emerging markets. If the Fed were to raise rates more quickly, investors may take fright.
“With this rate hike, Yellen has told the world the US economy is on the path to firm recovery. This is good news. It’s reassuring for emerging markets that the Fed has telegraphed a very ‘gradual’ tightening path,” said Levinson.
India’s economy has managed to dig itself out of a hole, and few think it still deserves to be included in the Fragile Five club. In 2013, a Morgan Stanley economist came up with the Fragile Five catchphrase to describe Turkey, Brazil, India, South Africa and Indonesia as economies that have become too dependent on skittish foreign investment to finance their growth ambitions. The phrase also raises concerns about the Fragile Five being able to withstand external shocks.
However, India’s economy, defying weakness in developed countries and elsewhere in Asia, has accelerated from 4.5 percent in the fiscal year 2012-13 to 7.4 percent in 2015, making it one of the world’s fastest-growing as China downshifts.
Bullish on India
Global fund managers are currently light on emerging market stocks and are likely to swoop in now to “fill out the holes” in their portfolios. With all the uncertainty surrounding Fed policy, investors had withdrawn a net $ 500 billion from emerging markets in 2015, the first annual outflow in decades.
There is a phenomenon of widow-dressing that happens at the end of reporting periods — near the end of a quarter and most certainly the end of the year.
“Better investor sentiment will activate fund managers. India will get its piece of that type of spending on shares,” said Seth Freeman, CEO and chief investment officer at San Francisco-based EM Capital Management LLC.
“The secular growth story for India in general is healthier than some other emerging economies,” he added.
India’s current account has swung from a record deficit of 6.8 percent of gross domestic product in the second quarter of 2013 through September, to a healthy surplus of 1.5 percent two years later.
India’s foreign exchange reserves, which allow a country to smooth out the impact of swings on forex markets and keep its currency stable, have passed the $ 350 billion mark, a sharp increase from the $ 275 billion in September 2013, when the crisis hit its peak and the desperate former Manmohan Singh government clamped down on gold imports.
Currency and Trade Impact
Investors anticipating the Fed’s rate decision have flocked back to the dollar, and the rupee has weakened. This week, it crossed 67 rupees to the dollar, a 2013 trading level. Analysts expect the RBI to intervene to prop up the rupee. This is also likely to put pressure on the current account deficit.
On the flip side, the strengthening of the dollar could have a positive impact on India’s export of goods and services. India’s goods exports fell on year for the ninth consecutive month in August. Its services exports, as a share of the total economy, also have languished.
“The interest rate hike in the US, though only 25 bps, marks an important shift in Fed policy which has held interest rates constant since June 2006. This policy shift is significant because it marks the beginning of an era of interest rate hikes, the first of which happened today,” said Sheila Hooda, President of New York-headquartered Alpha Advisory Partners.
“This will result in the continuing strengthening of the US dollar, and will result in a boost of exports from emerging markets like India… while potentially limiting the growth of imported goods. This first order effect will likely result in an improvement in the balance of trade for India,” added Hooda, a former McKinsey management consultant and investment banker with Credit Suisse.
New Delhi is hoping to raise India’s share of world trade to 3.5 percent by 2020 from 2 percent presently. Meeting its target of $ 900 billion in yearly exports by 2020 would require India to sell twice as much to the rest of the world as it does today.
Years of easy money policies and money printing by the US Federal Reserve have left trillions of dollars sloshing around the global financial system, turbo-charging emerging markets like India, and creating froth in all asset classes ranging from stocks, to real estate, to art and Bitcoins.