Fed rate hike may not act as cue for RBI4 min read . Updated: 19 Feb 2010, 11:29 PM IST
Fed rate hike may not act as cue for RBI
Fed rate hike may not act as cue for RBI
Mumbai: The decision on Thursday by the US Federal Reserve to hike the interest rate at which banks borrow short-term from it may not have an immediate impact on policymakers in India, since the higher discount rate is a signal that financial markets have stabilized rather than an attempt to tighten monetary policy, which is usually done by tweaking the Fed funds rate.
But given that India’s central bank has previously followed the Fed’s rate actions, the move will be a key input into the Reserve Bank of India’s (RBI) policymaking calculations, say economists and markets participants.
Equity, currency and bond markets in India reacted to the Fed raising its discount rate on loans given to banks by 0.25 percentage point to 0.75%. However, according to bond and currency traders, that was more because of global sentiment rather than a direct impact on the domestic economy.
The Fed funds rate is the more important policy rate in the US and the one that directly affects the flow of money and credit through the world economy.
The Fed reduced its target rate to 1.5% from 2% on 10 September 2008. RBI followed suit on 24 September by cutting key rates. By 16 December 2008, the Fed brought down its rate to 0.25% and RBI followed by cutting its rates in tranches to the present 3.25% for the reverse repurchase rate—at which it sucks out liquidity—and 4.75% for the repurchase rate—at which it injects liquidity into the system.
That was in sync with what other central banks were doing to protect their economies. This time, central banks are following their own unwinding process and economists expect RBI to chalk its own path.
The Bank of England at its recent meeting kept rates unchanged as China twice raised banks’ cash reserve requirements as did RBI at its last monetary policy announcement in January. The central banks of Australia and Israel have hiked their key rates.
However, India’s markets were not immune on Friday to the global movement set in motion by the Fed’s action. The dollar strengthened against 13 of the world’s 16 most active currencies. Stock markets, especially those in Asia, tumbled.
Taking a cue from weak Asian markets, India’s benchmark Sensex index fell 0.83% to close at 16,191.63 on Friday. The rupee weakened to 46.33 per dollar from the previous close of 46.27. The yield on the benchmark 10-year bond, which rose to 7.9% in the morning on speculation of a rate hike by RBI, recovered to close at 7.88%, almost flat from Thursday’s level of 7.86%. This followed the head of the Prime Minister’s economic advisory council C. Rangarajan saying the government’s borrowing in the next fiscal year may be lower than the current year’s Rs4.51 trillion.
The recovery in bond yields, according to bond traders such as S. Raghavan, head of treasury at IDBI Gilts Ltd, indicated that India was more bothered about domestic factors than signals from the Fed of a global recovery.
The only segment that could be affected by the Fed hike could be foreign institutional investors, as short-term rates will go up in the US. But market observers don’t read too much into the development.
“Yes, it has caught markets on the hop, since they were expecting tightening in Asia and not the US," said Deepak N. Lalwani, director at London-based brokerage Astaire and Partners Ltd. “But it’s not going to have much of an impact. People have been talking about it for quite some time."
Economists largely agree with market players. “We don’t need to read too much into it (Fed action) as it had been well flagged by Ben Bernanke and it has nothing to do with giving any monetary policy signal," said Rajeev Malik, head (India and Asean economies) at Macquarie Securities Group. “For RBI, domestic factors like inflation and growth dynamics will be relatively more important for its monetary policy stance than the latest Fed action."
Headline inflation accelerated to 8.56% in January, but RBI governor D. Subbarao said on Thursday that he expects to contain it at the projected level of 8.5% by March-end even as food inflation touched 17.97% during the week ended 6 February.
While the Index of Industrial Production for December grew at 16.8%, economists such as Devendra Kumar Pant, director of research at Fitch Ratings India, attributed this to the low base effect of last year. Just “signals of global recovery will not help", he said. “Aspects like a steady growth in domestic exports and manufacturing will be of paramount interest before RBI considers a rate hike."
Pant said the coming Budget, scheduled for 26 February, will be the deciding factor for RBI rather than any global signals.
Economists also point out that RBI has been at pains to signal that there will not be any rate action before its next policy announcement unless there are exceptional events.
“At this point in time, we believe that a rate hike could come only in the April policy," said A. Prasanna, chief economist at ICICI Securities Primary Dealership Ltd. “However, should primary articles’ prices fail to subside and/or fuel prices are hiked in a significant manner in the next few weeks, then action in March cannot be ruled out."
The hike could top his expectation of 0.5% as the “recent data on economic activity and prices have raised the question of a sharper hike".
Macquarie’s Malik expects it to be smaller—a 25 basis points hike in the April policy. A basis point is 0.01 percentage point.
Ravi Krishnan contributed to this story.