The Federal Open Market Committee (FOMC) of the US Federal Reserve, in its meeting on 19-20 March, decided not to raise interest rates. The FOMC believes the growth of economic activity and household spending in the US has slowed. Mint dwells on what it means for India.
What does the FOMC decision mean in the larger context?
In the aftermath of the 2008 financial crisis, the US Federal Reserve had decided to print a lot of money in order to bring down interest rates. The idea was to run an easy-money policy to encourage people to borrow and consume, and encourage corporations to borrow and expand. This happened to some extent. But the easy-money policy encouraged big institutional investors to borrow money in dollars at low interest rates and invest it in financial markets all over the world. By raising interest rates, the Fed wanted to reverse this easy-money policy.
What was the global financial market expecting?
Between December 2016 and December 2018, FOMC raised interest rates eight times, including four times in 2018 alone. This made it difficult for foreign institutional investors (FIIs) to use the easy-money policy of borrowing money in the US and investing it in India. In 2018, FIIs sold net stocks worth ₹2,751 crore and debt worth Rs47,795 crore. Financial markets in general do not wait for things to happen, they factor them in advance. Something similar has happened this time. The financial market had expected FOMC to stop raising rates and go back to the easy-money policy.
How have FIIs reacted to the FOMC move?
So far in March 2019, FIIs have invested ₹27,424 crore in Indian stocks, the highest in the last 24 months, besides buying debt securities worth ₹10,787 crore, the highest in 17 months.
What has been the impact on the stock market?
The buying by FIIs resulted in the BSE benchmark Sensex rising by 6.4% in March. Several stockbrokers have called this a rally in expectation of Narendra Modi coming back for a second term as prime minister. While the stock market loves the idea of Modi becoming the PM again, this is also an easy-money rally, fuelled by the expectations of cheaper borrowing in the US. It is highly unlikely that FOMC will raise interest rates this year and this has got FIIs interested.
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How is all this linked to rupee appreciation?
When FIIs bring in US dollars into India, they need to convert it into rupees. This pushes up the demand for the rupee and helps the Indian currency appreciate. In March, the rupee appreciated 3.2% against the US dollar. One dollar was worth ₹68.9 as of 22 March, against ₹71.2 in February-end. If interest rates in the US do not rise and oil prices stay low, the rupee will remain strong against the dollar.
Vivek Kaul is an economist and the author of the 'Easy Money' trilogy.