This week US Fed has reaffirmed plans to leave its benchmark interest rates pinned near zero through at least 2023.
*Implications for India* :- A signal to maintain lower rates in the US should be positive for emerging market economies (EMEs), especially from a debt market perspective. Emerging economies such as India tend to have higher inflation and higher interest rates than in developed countries. As a result, FIIs would want to borrow in the US at low interest rates in dollar terms, and invest that money in bonds of countries such as India in rupee terms to earn a higher rate of interest.
When the Fed keeps its interest rates low, the difference between the interest rates of the two countries increases, thus making countries such as India more attractive for the currency carry trade.
A lower rate signal by the Fed would also mean a greater impetus to growth in the US, which could be positive news for global growth. But equally, this could translate into more equity investments in the US, and temper investor enthusiasm for emerging market economies.
*RBI stance on growtg and inflation* :-While the RBI’s Monetary Policy Committee decided to keep the policy rates unchanged in the meeting held earlier this month, Governor Shaktikata Das has said that it is important to keep the powder dry and to use it judiciously. He also said that given the uncertain inflation outlook, it is important to see the momentum in inflation, which is also dependent on effective supply-side measures.
The problem for RBI is the effectiveness of its monetary policy signal. It has cut the repo rate by 250 basis points from 6.5 per cent to 4 per cent in the 17-month period from February 2019 to June 2020, but existing borrowers have gained very little. Data show that the weighted average lending rates on outstanding rupee loans has come down by only 53 bps, almost a fifth of the cut in the policy repo rate.
The result is that even though the policy signal has been in favour of a sharp reduction in interest rates, practically all existing borrowers continue to pay a higher rate on their borrowings, thereby limiting the upside of the RBI’s policy guidance.
Meanwhile, retail inflation, while easing slightly in August as food inflation cooled, continues to remain above the upper end of RBI’s medium-term target for the fifth straight month. The concern is this will result in inflationary expectations inching up, which could put further upward pressure on the actual inflation trajectory. With elevated inflation in the near term, there is reduced room for policy easing, at least until the RBI’s December bi-monthly policy review.