MUMBAI: The US Federal Reserve has prepared the global markets for its first rate increase in about nine years. The March 17-18 Fed meetings didn’t commit a date but gave a broad indication the rate increase is not too distant.
As major markets across the globe cheered Fed chief Janet Yellen said its data doesn’t necessarily indicate that an increase will necessarily occur in June. Yet, she also held out a polite caution that an increase in its rate it can’t be ruled out either.
While India’s 10-year government bond yield fell four basis points to 7.75 per cent, the Sensex initially gained 356 points only to slide 152 points on selling for profit towards the close.
“Yellen has rocked the boat,’’ said U R Bhat, a director at Dalton Capital in Mumbai. “Increase in the US rate may happen in June or in the June-September quarter. Investors have sufficient time to restructure their portfolios, unlike in mid-2013 when it was unexpected so there was severe turbulence across markets.’’
Local companies have a sufficient notice to restructure their positions vis-a-vis overseas borrowings.
Christine Lagarde, Managing Director of International Monetary Fund earlier this week cautioned Indian companies to be watchful of turbulence in global currency markets.
“The risk of financial market and capital flow volatility, along with sudden increases in interest rate spreads, remains a real possibility as the US interest rates begin to rise,’’ Lagarde said in Mumbai.
“The appreciation of the US dollar is putting pressure on balance sheets of banks, firms, and households that borrow in dollars but have assets or earnings in other currencies,’’ she said. “India’s corporate sector, which has borrowed heavily in foreign currency, is not immune to this vulnerability. Corporate sector debt has risen very rapidly, nearly doubling in the last five years to about $120 billion.’’
Fortunately for India, attractiveness of its debt and equity markets ensured strong overseas inflows over the past nine months. The Reserve Bank of India kept mopping up dollars to prevent the rupee from appreciating and in the process increasing its foreign exchange reserves.
The additional reserves could come in handy in case of a flight of capital when the Fed raises the rates.
India is better prepared, RBI Governor Raghuram Rajan said in a confidence boosting statement. Yet, a lot would depend on how effectively central banks across the globe coordinate policies. But since Europe, and Japan is in a different phase compared with the US and the UK, coordination may not be as smooth.
Some analysts are concerned that increase in US rates may delay further cuts in Indian interest rates as it would narrow interest rate differential between the two countries. Relatively lower yield could make Indian debt less attractive for overseas investors.
What about equity? For global funds India may still be one of the few markets that offer relatively better returns, so this could at least slow any outflows from equities.
“A lot would also be conditional on corporate earnings for the coming quarter and also how smoothly the government is able to pass and implement economic reforms,’’ says Bhat from Dalton Capital.