At Fed’s mercy – The Hindu BusinessLine

Clipped from:

The Fed rate hike is set to force the MPC’s hand in the meeting next week

The Federal Reserve’s continued fight for price stability is creating problems for countries across the world. On Wednesday, the Fed jacked up its funds rate by another 75 basis points — the third in succession — even as it made aggressive projections regarding future rate hikes. The hawkishness is despite a sharp growth deceleration in the US economy. Financial markets are in turmoil globally after the Fed policy announcement, as its actions have ramifications for not just global growth but also for the monetary policies of other central banks. As if on cue, the Bank of England raised its policy rate by 50 basis points and the Swiss National Bank raised policy rate by 75 basis points following the FOMC meet this week.

It is clear now that we are set to see interest rates rise across the globe well into the next calendar year. The developed world, mainly the US and Euro Zone, are caught in a vicious downward spiral of rising interest rates and falling growth. The US has already slipped into a technical recession and the Fed is now projecting real GDP growth for 2022 at 0.2 per cent, down from 1.7 per cent projected in June. The UK and Euro Zone are expected to enter a recessionary phase later this year and global growth projections for 2022 and 2023 are being slashed sharply by economists. While the West’s troubles can be dismissed as a problem of their own making, the point is that in a globalised world there is collateral damage on developing and less developed economies in Asia and Africa. Besides the impact on trade, emerging market economies also have to deal with accelerated portfolio outflows as the yield on US treasury securities move higher. A stronger dollar, as a consequence of the Fed’s actions is weakening emerging market currencies further; the rupee has been pushed down to the 81 mark against the greenback, creating problems for the Reserve Bank of India (RBI) and the government.

The rupee’s prospects will be the elephant in the room as the MPC meets next week. It may not be wrong to suggest that the MPC’s policymaking is increasingly hostage to that of the Fed. The MPC’s only remit is to tame inflation, but yet it cannot ignore the fact that capital outflows or inflows drying up due to asynchronous rates between India and the US can lead to macro-economic instability. The problem is that the central bank does not have too much room to intervene actively in support of the rupee with forex reserves declining around 14 per cent from last year’s peak. Market intervention to support the rupee will also suck up liquidity in the system. It’s due to this constraint that the RBI and the Centre have taken various non-monetary measures to support the external account and the rupee over the last few months. Markets and borrowers in India will have to brace themselves for an extended domestic rate hike cycle, and settle for a lower pace of GDP growth.

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