The last Fed meeting was a turning point as things have changed across countries almost in harmony. The Fed did what it wanted to do, which was expected, with an increase in rates by 75 bps. But the indication given is that its action will become tempered, which means that it will be less aggressive in the future, though rates will probably still go towards the 5% mark next year. The signals, however, have been quite strong across all the markets, and India, too, has benefited a lot. The rupee, it may be remembered, had moved towards the 83 to the dollar mark, and forecasters did not feel shy to even talk of 85. However, with the Fed’s announcement, the dollar has started weakening with the dollar index moving down. Collateral benefits have been witnessed across most currencies. The rupee, too, has now moved to the 81-82/$ range and the question asked now is whether this will be a phase of appreciation that can go below 80/$.
The rupee has been guided by two sets of factors. The first is the external one which had the strong dollar driving all currencies down. The rupee did better compared to other currencies. Now with the dollar weakening somewhat, the rupee has gained. And this will continue as the dollar gets softer as the economy slows down. The second relates to fundamentals. The trade deficit has been widening primarily because exports are declining, which is expected due to the slowdown in the global economy. Imports growth has receded due to commodity prices easing, but it is still higher than that of exports, thus widening the trade deficit. Software receipts, too, would slowdown as demand for such services, particularly from the US, would be impacted. A lot now depends on how the FPI flows behave. They have been positive from the last week of October and all through November, which has helped to firm up the rupee on a daily basis. But for how long will this last? Normally, the FPIs square up their positions towards December when they repatriate their profit. In case they do so, the net inflows can turn negative, in which case the rupee will be impacted in the reverse direction.
The Fed action also had a salubrious effect on the stock markets, and the Sensex has been on an upward trajectory aided by the FPI inflows. This is quite surprising because the corporates that have announced their results for the second quarter have, in general, shown a smart increase in turnover though a decline in profits. In fact, this has been the paradox across most non-financial sectors where turnover recovered due to pent-up demand, but profits came down due to higher input costs. Clearly, the profit logic of today does not work in evaluating value tomorrow, as the stock market has brushed these results aside as being only transient. The long-term story remains intact.
The other consequence of the Fed tempering its commentary is that the bond yields have come off highs, even in the USA and European markets. The US 10-year treasury yield was closer to the 4% mark as long as there was uncertainty regarding the Fed’s move. But now, things have changed, and the softer stance has brought the yields down. This has also worked through the Indian market where the 10-year yield, which had been displaying rather volatile tendencies, has moderated to less than the 7.3% mark. It may be recalled that the earlier Fed action and tone had driven the yield past the 7.6% mark. It was moderated when there was news of the Indian bonds being included in global indices. The deferment of this inclusion drove the rates up to the 7.4-7.5% range, and now the trajectory seems to be downwards toward the 7.2% mark.
Therefore, while there is a lot of talk and speculation on RBI action, which can provide forward guidance for the market, it has been observed that the Fed’s action has an equivalent impact on domestic markets. And this can be felt even before RBI takes a call. In fact, the RBI rate hikes have not quite brought about a similar reaction in the bond market, though liquidity considerations have impacted the lower maturity yields. But the benchmark 10-year bond has been more or less resilient to RBI action. Similarly, RBI’s actions in the forex market were not able to do what the Fed announcement did, as it does appear that our fundamentals may not be that strong to warrant an appreciation. However, the global spillover effect has been impactful.
The power of globalisation has hence been more evident in the three markets like never before. The global slowdown or the action taken by Jerome Powell leaves an indelible mark for sure and cannot be brushed aside. It is not surprising that in the last monetary policy meeting, the RBI governor highlighted the importance of the announcements of the central banks of advanced economies.
The writer is chief economist, Bank of Baroda
Views are personal