The rate hike by the Fed is almost certain, as is the quantum and roadmap for further increases in interest
rates during the course of 2016. It may be recollected that the Fed had brought down interest rates close
to zero in 2008 following the financial crisis. The tightening started in 2014 when the QE programme was
tapered down to nil over a period of time on considerations of growth taking off and inflation concerns
increasing. The unemployment rate appears to be within the 5% level to reassure that growth has taken off
and inflation can be a problem. Statements made by the Fed in the past, as also on the day when the ECB
has continued to persevere with QE, indicate that the rate hike is imminent this time and there will be no
further deferment.
Going by theory any hike in rates will make the dollar stronger in the currency market and by implication
the other currencies will weaken. This would be heightened by the stronger growth impulses emanating
from the domestic economy.
The markets have reacted with panic just as the Fed meeting begins today. Interest rates have started
moving up in the domestic market and the rupee has declined once again to cross the psychological
threshold of Rs 67/$. Why is this happening?
The certain increase in rates has caused foreign investors to pull out from emerging markets; and hence
while these countries benefited from the QE measures which supplied cheap money that was partly used
to invest in these markets; a withdrawal means that there would be less interest in them. FIIs have
withdrawn $ 1.64 bn in November from the Indian market and the outflows so far in December are $ 852
mn. Hence, while our overall balance of payments situation looks stable as evidenced by the movements in
forex reserves, the rupee continues to be under pressure as demand-supply imbalances have resulted also
at the prospects of FII pullout and further depreciation. Demand for dollars has increased as importers are
rushing in.
$ mn
December 15, 2015
Economics
Understanding the Fed rate hike
Exhibit 1: Forex reserves movements since March end
360
355
350
345
340
335
330
352.1
341.4
4-Dec-15
20-Nov-15
6-Nov-15
23-Oct-15
9-Oct-15
25-Sep-15
11-Sep-15
28-Aug-15
14-Aug-15
31-Jul-15
17-Jul-15
3-Jul-15
19-Jun-15
5-Jun-15
22-May-15
8-May-15
24-Apr-15
10-Apr-15
27-Mar-15
The stock markets have also reacted negatively to such news and coupled with the outflow of FIIs, have
trended downwards thus negating the forecast made earlier of the Sensex touching 30,000 by March end.
1
Economics
Exhibit 2: Movement in Sensex
14-Dec-15
12-Dec-15
10-Dec-15
8-Dec-15
6-Dec-15
4-Dec-15
2-Dec-15
30-Nov-15
28-Nov-15
26-Nov-15
24-Nov-15
22-Nov-15
20-Nov-15
18-Nov-15
16-Nov-15
14-Nov-15
12-Nov-15
10-Nov-15
8-Nov-15
6-Nov-15
4-Nov-15
2-Nov-15
27,000.00
26,500.00
26,000.00
25,500.00
25,000.00
24,500.00
24,000.00
Is it specific to India?
Almost all emerging markets currencies have witnessed a decline in value in December as shown in the
diagram below. Therefore, the fall in the rupee is not really unusual to cause concern.
Exhibit 3:Currency depreciation Dec 1st to Dec 14
7.00
6.02
6.00
5.00
4.94
5.00
4.00
3.00
1.65
0.96
0.94
0.60
1.00
0.73
0.89
Baht
1.10
Taiw dollar
2.00
3.15
2.52
2.21
0.04
0.00
Turkey lira
Won
Rand
Sing dollar
Ruble
Phil Peso
Mex Peso
Ringgit
Rupiah
Rupee
Yuan
Real
The RBI’s actions in the past in both the spot market as well as the exchange traded currency derivative
markets have added to the panic. Central bank intervention in any market is interpreted as a correction
which leads to further conjectures on rate movements.
Money markets
Simultaneously, the money market has tightened with money supply under pressure with the withdrawal
of FIIs thus leading to GSec yields moving up. The repo limits have been virtually exhausted – both
overnight and term put together. This has been heightened by the slower growth in deposits too up to
November end where growth was 6.9% over March compared with 7.2% last year. There are expectations
of announcements of OMOs by the RBI to buyback bonds to inject liquidity.
Understanding the Fed rate hike
2
Economics
%
Exhibit 4: GSec 10 year yield
7.89
7.69
12/14/2015
12/12/2015
12/10/2015
12/8/2015
12/6/2015
12/4/2015
12/2/2015
11/30/2015
11/28/2015
11/26/2015
11/24/2015
11/22/2015
11/20/2015
11/18/2015
11/16/2015
11/14/2015
11/12/2015
11/10/2015
11/8/2015
11/6/2015
11/4/2015
11/2/2015
7.95
7.90
7.85
7.80
7.75
7.70
7.65
7.60
7.55
Source: FIMMDA
What now to expect?
With the rise interest rate by Fed, foreign investors would exhibit an impulsive reaction of withdrawing
money from India adversely impacting the rupee and thereby creating pressure on RBI.
The view here is that most of this phenomenon is due to expectations of a Fed rate hike and are not long
lasting in nature. Just like how the QE tapering news was more potent than the actual tapering, markets
will self-adjust once the rate hike is announced as this news gets factored in. At this stage however, the
central bank’s comfort level has to be gauged to understand if an exchange rate is being targeted which
can create expectations. The balance of payments appear to be stable to justify a range of around Rs 66/$
though volatility in the FII flows and demand-supply imbalances can keep it closer to the Rs 66-66.5 range.
GSec yields should correct in course of time and the present tendency to increase should get arrested. A
range of 7.6-7.7% appears to be the fair value given the state of the deficit, credit growth and medium
term liquidity.
Going ahead, we shall expect the situation to even out once the dollar stabilizes making the inflows into
the Indian economy and other emerging economies more favorable. This shall also give a clearer picture to
RBI to take its stance in its next monetary policy.
Contact:
Madan Sabnavis
Chief Economist
madan.sabnavis@careratings.com
91-022-67543489
Jyoti Wadhwani
Associate Economist
jyoti.wadhwani@careratings.com
91-022-67543531
Disclaimer
This report is prepared by Credit Analysis &Research Limited (CARE Ratings). CARERatings has taken utmost care to ensure accuracy
and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor
completeness of information contained in this report is guaranteed. CARE Ratings is not responsible for any errors or omissions in
analysis/inferences/views or for results obtained from the use of information contained in this report and especially states that CARE
Ratings has no financial liability whatsoever to the user of this report.
Understanding the Fed rate hike
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