So, even the mighty America cannot act in isolation. In the interlinked global economic world it was only to be expected that the much ballyhooed Fed rate hike would be put off for another day. The decision by the US Federal Reserve was widely expected. And it had been largely discounted by the Indian share markets. The US economy might be gathering momentum, the unemployment rate might be down to a manageable five percent or so, and the consumer inflation too might well be under control, but the tremors in the second largest economy in the world have obliged the managers of the largest economy to stay their hand and hold back even a modest 25 basis point hike in the benchmark bank rate. Such then is the nature of the inter-dependent economic world.
Federal Reserve President Janet Yellen, after two days of deliberations, said on Thursday that ‘outlook in China, other emerging economies have become more uncertain now… the pace of rate rises will be gradual…’ Even without the rate hike, the dollar was getting stronger, especially following the sharp drop in the Shanghai-listed stocks. Clearly, the rise, if any, can now come only in December, if at all. For, the situation in China is unlikely to improve anytime soon. Despite the artificial props by Beijing, the sentiment on the Shanghai and other Chinese share markets continues to be weak. Investors are pulling out their money. And foreign investors are rapidly taking out their money as well. In fact, the Chinese leadership is worried by the outgo of money by their own compatriots, especially in the wake of fears about the economic slowdown. It is notable that the interest rates in the US have remained unchanged at near zero since 2008. Though last year the Fed had begun to tamp down on quantitative easing as a precursor to the eventual rate hike, Yellen and her colleagues on the monetary committee thought it pragmatic not to cause tremors in the global markets at a time when it has yet not fully absorbed the bad news coming out of China. Significantly, there is no unanimity within the economic community whether or not it was wise for the Fed not to raise the rate on Thursday.
If there are a number of economic pundits who have endorsed the status quo decision, there are others who are equally vociferous in arguing that the Fed ought to have raised the rate by at least 25 basis points. The truth is that the US economy takes a direct hit when it maintains the rate virtually at zero. It has been argued that the US Fed can boost domestic growth by increasing the rate a wee-bit. Clearly, concerns about the Chinese economy preyed heavily on the minds of Yellen and Co. The impact of the no-change decision on the Indian markets predictably was positive. The bellwether Sensex closed 255 points higher while Nifty saw a gain of 83 points on Friday. However, the impact of the no-change goes beyond the stock markets. Now, the feared outgo of foreign funds, not only from the share markets but from industry and trade, might not happen. In fact, with the Chinese economy in the grip of a severe slowdown, investible foreign dollars might find India an attractive destination, especially when the Prime Minister’s accent on Make in India and other incentives to speed up the economic engine are beginning to bear fruit. Besides, India today is the most attractive economy in the developing world following the sharp fall in the global prices of crude and commodities. The twin deficits are also down to manageable limits and the Indian currency has seen a welcome correction to make the exports competitive.
Contrary to the popular perception, the rupee is still a bit over-valued according to the economic pundits. Yet, the overall prospects of the economy seem optimistic. The Modi Government has taken steps in key sectors such power, roads, communications, defence production, etc., which should begin to show results in a few years. The Fed decision to leave the bank rate unchanged was already been factored in by the Indian policy makers, including the RBI, as well as the share markets but its formal confirmation is an added opportunity to gain from the continuing woes of China and to build a credible manufacturing and export sector. Meanwhile, the RBI should now actively consider at least a 25 basis point cut in the bank rate.
