US Fed fence-sitting on rates offers reprieve on flows into India

After obliging markets with a 25-basis point cut in its policy rates for the first time in eleven years, the US Federal Reserve has thrown them for a loop by stating that this may not be the beginning of a new easing cycle. After announcing the cut, the Fed Chairman took a mostly favourable view of the American economy and indicated that this rate cut was to ensure that the economic expansion was sustained amid weak global growth and trade tensions. The cut has been described as a ‘mid-cycle adjustment’, with incoming data likely to set the future course for rates. The Fed’s decision appears quite justified given strong US indicators on employment and consumer demand. But it has had global financial markets swooning in disappointment. Indian stocks, which hadn’t participated at all in the global rally of 2019 (having been in a sulk over domestic economic woes), reacted in sympathy.

The mixed signals from the US Fed are reflective of the deeper dilemma that central bankers across the developed world face after pursuing extra-ordinary monetary policies for over a decade. The shift to zero to negative interest rates was initially intended to lift developed economies from the stupor induced by the global financial crisis. But with both the political class and financial markets getting addicted to the cheap money, normalising them has proved impossible. With fresh threats now hovering over the global economy in the form of US-China trade wars, the US is rethinking its tightening while the ECB and Japanese central banks are set on further accommodation. For emerging markets such as India, this low-rate regime has meant an active dollar carry trade that has inflated stock valuations, fuelled opportunistic bets on local bonds and aided aggressive private equity bets on start-ups. Continued monetary tightening by the Fed would have resulted in a painful popping of these bubbles and its fence-sitting now offers a temporary reprieve.

The Fed’s actions may aggravate the dilemma for India’s Monetary Policy Committee as it meets next week to decide on policy rates. Having effected three rate cuts totalling to 75 basis points in 2019, the RBI’s repo rate is already at 5.75 per cent, a level rarely seen in the last twenty years. But markets continue to clamour for lower rates, as high frequency indicators are sending out distress signals on the economy. Before contemplating further rate cuts at this juncture, the RBI will have to weigh the risk of alienating FPI flows. While borrowing costs for the Government are down sharply, there’s no let-up in the risk aversion towards private borrowers. Clearly, Indian policymakers, like their global counterparts, are running out of easy fixes to the economy’s persisting woes. It is more important than ever for the NDA government to widen the intellectual bandwidth in its economic policy-making, and to pay heed to sane voices from the industry and the economy, outside the Government.

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