Why India may come out on top after Fed rate hike

March 17, 2015

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

The U.S. Federal Reserve’s policy meeting (March 17-18) is the main focus for markets this week as the world waits to hear its intentions on interest rates.

Markets were rattled by U.S. payroll and unemployment data for February due to fears that the Fed will raise interest rates sooner than expected, despite its pledge to be “patient” in its last policy meet.

However, what markets are not considering is that the Fed will also look at U.S. core inflation and the global macro-economic situation, the latter a cause of much concern, especially the euro zone. Also, except for unemployment data, other macro data from the U.S. are consistently disappointing and volatile.

Fed funds futures are indicating the probability of a rate hike in June at 19 percent and 58 percent for September. The key impact of a rate hike would be on the strength of the dollar. A strong dollar is “assumed” to have a negative macro impact on the U.S. economy in terms of external trade, competitiveness of domestic industry and the profits accruing to U.S. multinationals.

However, the effects of a strong dollar on the U.S. economy can be argued with analysis of past data. Between 1982 and 2000, as the dollar skyrocketed 178 percent, the country’s stock markets jumped 1,099 percent, and nearly 40 million jobs were added with 3.5 percent average annual real GDP growth rate.

When the dollar declined from 2001 to 2011, a paltry 23 million jobs were added, real GDP growth averaged less than 2 percent, and the S&P gained a measly 15 percent. And let’s not forget the dreadful 1970s: The dollar plunged, the economy suffered through years of stagflation, and the real value of stocks fell significantly.

As far as the rupee is concerned, as of last week, it was the only emerging markets currency which appreciated in the past year against the dollar, despite the dollar index hitting new highs every day in anticipation of a Fed rate hike. This can be attributed to the inherent strength of Indian economy, supported by steady reforms being brought in by the BJP government and strong FPI inflows.

With key global rating agencies approving the reforms agenda of the government, the rupee will most likely outperform its peers when the Fed eventually hikes rates. This will prevent FPI outflows from India and will support the currency and markets. There is a case building up for India getting delinked from other major economies.

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