US rate hike a double whammy for Indian economy; may lead to price rise, slowdown, budget has to be soft
The US Federal Reserve rate hike of 0.25 percent is likely to have impact on Indian economy with increased outflow of foreign portfolio and institutional investors.
It may also force in the course of time to raise rates in India. The RBI kept it stagnant in its monetary policy some days back as it wanted to observe the US Fed move.
Outflow of foreign portfolio investment has already topped Rs 10,700 crore in November in anticipation of US rate hike. This is worst ever data available since 2002 showed. This has triggered a selloff in stocks of companies with high FII holdings.
It reflects a strengthening US economy that is likely to make the emerging markets vulnerable to volatile capital outflows says international rating agency Moody’s says.
The US economy, Moody’s says, should continue to expand through 2018 and emerging markets exporters will benefit if US growth translates into higher import demand.
In other words India may see a rise in outflows but as the US economy improves it can expect some rise in exports provided the Donald Trump regime allows such imports.
However, a signal from the US Fed will ultimately lead to subsequent rate hikes. A series of hikes in interest rates in the US over a period of time will raise the borrowing cost for carry trade (borrow from US and invest in India), and thereby reduce their risk-adjusted return in India.
On the other hand, the Reserve Bank of India has embarked on cutting interest rates, and has cut repo rates twice by 25 bps each. A cut in India and a hike in US further reduce their risk-adjusted return. Experts also say that this may make US bonds more lucrative.
So would it give another shock after demonetization? It is not necessary but there are apprehensions that if the US economy improves and announces two more rate hikes in the next 12 months it can impact investments in India. Some of the promised foreign investments may either be delayed or not come. Some may be revised downwards.
It is too early to predict its impact on the overall growth projections. It has led rupee prone to more shocks. Rupee weakened by 43 paise against dollar as gained against global currencies. It may slip further as demonetization has made the economy shaky.
Besides, foreign fund outflows also kept pressure on the rupee.
This makes imports particularly petroleum crude expensive. It may have inflationary pressure on the economy as hike in petroleum prices would lead to higher transportation costs. It may have minor impact also on forex reserves particularly as there is thaw in exports amid global uncertainties.
Exports were also hit, owing to cash crunch, says commerce secretary Rita Teaotia. But despite the problem, exports are expected to reach $ 280 billion by March, 2017, as against $ 261.13 billion in 2015-16, some fall in target is likely.
The US rate hike and industrial production data for October 2016, the last point before demonetisation, released on Dec 9 showed that overall industrial output contracted by 1.9 percent. The fall over September was steeper at -6.3 percent. The index (IIP) has grown by -0.3 percent this year so far (April-October), compared to a corresponding 4.8 percent growth last year. This shows how weak industrial activity was even without demonetization.
Growth in consumer goods, although positive at 1.2 percent in the year so far, was weaker than the last year. And capital goods output growth was -22 percent in the period (-26 percent in October) relative to a decent 9 percent growth in April-October 2015.
Production actually dropped in April-October across mining (-0.2 percent against 2.2 percent last year) and manufacturing (-1.0 percent against 5 percent growth in April-October 2015) with only electricity segment showing positive, 4.6% growth.
Demonetisation may hurt demand with consumer goods being the worst affected. Cement sale volumes halved in November. Developers are pruning overall costs, including staff, to economize on cash and sustain bottom lines. Ripple effects will be felt in steel and other inputs as well. Automobile sales in November were 5.48 percent lower—the slide is expected to accelerate in coming months as sagging retail sales feed back to manufacturers who may even cut output in next round. Consumer goods’ firms whose sales volumes either fell or grew feebly in September quarter will also get impacted.
The credit growth fall by over Rs 65,000 crore (Nov 11 to 25) indicates weak demand and production. The total fall may exceed Rs 1 lakh crore.
The impact of demonetisation on industry may be indicated from December data, which will arrive only in February, 2017.
The government is treading on difficult path. The daily wagers including MNREGA labourers are either facing job losses or severe cash crunch.
The migrants are going back home. Cash crunch is hitting industry, farm sector, mandis, vegetable, onion and potato prices. It has also caused sharp rise in wheat prices as the market sees production fall.
The fall in retail inflation indicates that consumer is unable to make purchases. Even the credit-card servers are collapsing owing to excessive load.
Steps are needed to check rise in prices as the market comes out of shock may be by mid-January in the wake of interest rates hike by US Fed Reserve and oil price hike.
The government has to carve out the budget carefully to maintain its popular support, create demand and jobs. It should resist the temptation of increasing rail fares or reduce so-called Rs 21,391 crore “subsidies”. Another white paper on rail accounting processes, of two decades, should also be considered.
Many have given up LPG subsidy but it has caused resentment as well, more so as deposit interest rate falls. The announcement for linking Aadhar to senior citizen rail tickets may lead to harassment by rail staff and consequent ire against the government.
People are expecting cut in income tax rates, doing away with TDS on bank deposits, decision on floor deposit rate of 9 percent and other necessary real reforms for ease of business and job growth. The tax reforms are needed to win popular support as five states, including UP, Punjab and Goa go to polls.
The government is faced with challenges. It has to come up with innovative popular ideas to maintain its support base witnessed during the 2014 polls.