1. US Federal monetary policy meeting effect on India: 4 top points

US Federal monetary policy meeting effect on India: 4 top points

There is not much in the Federal Open Market Committee (FOMC) monetary policy event that was not expected...

Updated: January 29, 2015 6:11 PM
US Federal, US Federal Reserve, US Federal policy

US Fed is now more optimistic about growth and labour market performance. (Reuters)

There is not much in the Federal Open Market Committee (FOMC) monetary policy event that was not expected – the FOMC retained its policy band of 0-0.25% and also retained the term that it can be “patient” in hiking rates. Compared to the previous communication, US Fed is now more optimistic about growth and labour market performance. There appears to be some continued scepticism on household spending that was assessed to be rising moderately even as the decline in energy prices boosted household purchasing power. Further, inflation is expected to move lower in the near term due to the pressure of declining energy prices but the broad expectation remains that the energy effect will be transitory and hence inflation will eventually gradually rise to the 2% medium term outlook. The immediate reaction to the policy is a fall in US equities, softer US treasury yields (dropping by 10 bps on the 10-year maturity) and a gain in the USD.

There is only cautious optimism from a global perspective. Europe appears to be struggling, the US is the only country that is showing some growth. However, the doubt is that if the rest of the world does not perform, the US cannot stand on its own, even though it is predominantly a domestic economy. Do note that the current appreciating US$ has anyway tightened policy stance in the US and that could probably shift the ultimate date of US policy tightening to around September 2015 from the currently priced-in June 2015.

It would be interesting to understand the implications of what is taking place globally on India.

1. On one side there is a huge amount of liquidity that would be sloshing around from March when the QE by the ECB gets under way. Some of this will definitely come to India as it is one of the most stable economies at this point in Asia. This means that there would a tendency for the INR to appreciate but we believe that RBI will keep a tight leash on the currency by accumulating reserves.

2. With the US-10-year continuing to trend lower, the gap between the domestic and US yields have opened up further and any eventual rise in the US policy rate might turn out to be not as taxing for India as was the “QE taper tantrums”.

3. The higher yield gap also provides the RBI more room to cut rates. However, we believe that the RBI will continue to tread cautiously and would like to analyse each risk at a time. Thus, the pace of rate cuts by the Reserve Bank of India (RBI) will be well restricted to only 25 bps per cut and the length on the cycle could extend only till a 75-100 bps cumulative, of which 25 bps is already done.

4. The next cut in policy rates expected by us is in the 1st week of March (after the RBI has taken on board the implications of the Union Budget) and not on 3rd February. Thereafter, we expect one more cut to come in June 2015, after which an assessment of the current situation and risks would be relevant for the RBI to take further decisions.

By Indranil Pan, Chief Economist, Kotak Mahindra Bank

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