India Economy

Rajan and Yellen on interest rate see-saw

 J Mulraj | Updated on January 22, 2018



Rates may go up at one end, down at another, but the measures may be only symbolic

Janet Yellen, US Federal Reserve Chair, has been for long hinting at a commencement of the up-cycle of US interest rates, which are now near zero and are not helping the economy but only the banks and financial intermediaries that invest in assets. In India, there is pressure on the RBI Governor to reduce rates which he has sensibly avoided doing.

So, it seems like a see-saw game, with interest rates going up at one end and down at another.

For stock markets, the more important factor is what Yellen will do at the FOMC meeting.

In August, non-farm jobs grew at 1,73,000. This was lower than expected, but the unemployment rate fell from 5.3 per cent to 5.1 per cent, close enough to the target of 5 per cent for a rate hike to be considered.

But Yellen has three fears on raising interest rates, all related to capital markets.

One, there is a carry trade — where investors borrow in one currency at low interest rates and invest in assets in another currency — estimated to be $9 trillion in the US.

So long as the yield is higher than the cost of carry plus covers the currency risk, the trade is profitable. If interest rates rise significantly, the trade starts to unwind. Investors sell assets in other countries/currencies.

Another risk is that of interest rate derivative products that protect the buyer from adverse impact of changing interest rates. Big banks are supposed to be holding $150 trillion of these and hike in rates can wipe out the capital of these banks.

And, of course, rising interest rates will impact the profit margins of US companies and thus their valuations, and cause a fall in their stock prices.

Several US Shale companies are facing bankruptcies because of falling crude prices, and cannot bear higher interest rates. US companies have $4 trillion of debt maturing in the next five years that needs to be rolled over and an increase in interest rates will make it tougher. An increase in interest rates will also further strengthen the dollar, which has already appreciated.

So one expects Yellen to raise rates only symbolically, if at all.

Local issues

For Raghuram Rajan the decision to cut interest rates, as he is being pressured to do, has to be balanced with several factors.

He has to factor in the likelihood of capital flight if Yellen raises interest rates significantly. He, too, may cut interest rates only symbolically.

Rajan, like other policy makers, is concerned about job growth. To put things in perspective, India needs to create over 10 million jobs a year, or 8,00,000 per month. Far more than the figure of 1,73,000 new jobs in the US.

But interest rate cut alone is not going to propel job growth. That will come from more sensible economic policies.

We have 27 banks in which Government owns a majority. They control 70 per cent of India’s deposits and loans.

Their job is to direct money from savers to those who put up projects. Judging by their high NPA levels, compared to private banks, and their lower productivity levels they do not do the best job.

The safety of the financial system can be assured by holding a majority in two or three large banks.

The investigative and judicial system is far too slow and far too lenient with criminals.

In telecom, shortage of spectrum has led to higher cost of buying it, leaving less for capex (hence the call drops).

We need to unclog these critical systems.

Last week the sensex gained 408 points to close at  25,610.

India is in a better position among emerging markets, given that Brazil’s rating was lowered to junk status by S&P.

(The writer is India Head, Euromoney Conferences)

Published on September 13, 2015

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