Never has a Fed rate hike seemed more likely. Short-term treasury yields are at five-year highs in expectation of the move mid-December. Financial turbulence arising out of the slide of the yuan and the crash of Chinese stocks had ruled out a rate hike in September and October. Besides, there was Greece on the horizon. These uncertainties have ebbed, while geo-political risks arising out of instability in West Asia are yet to translate into financial and economic ones in the OECD world. On the other side, the US is showing a job revival of sorts, which the Fed was perhaps waiting for. While an inflation rate of 1.5 per cent is still below the Fed’s lower band of 2 per cent, pointing to the slack in the economy, studies suggest that the recent rise in US house rents is not wholly captured by this measure. The Fed is also aware of the pitfalls of an extended run, now seven years long, of virtually zero interest rates. These have created asset inflation in the US and elsewhere (a fact that Reserve Bank of India governor Raghuram Rajan never tires of spelling out). They have not helped lift household savings and future incomes and have not translated into credit for US small businesses. While the world’s largest economy is clambering back on its feet, there is a growing view that quantitative easing has spurred socio-economic inequalities, apart, of course, from proving a nuisance for central bankers in emerging economies. An era of incredibly easy and footloose money is gradually drawing to a close. But this should not be cause for alarm in India, even as short-term volatility in the currency cannot be ruled out.
India is in a sweet spot. An economy growing at 7.5-8 per cent — with a stable currency, twin deficits in control and benign inflation — looks like a promising long-term bet for investors. The Centre’s move to liberalise FDI caps is well timed; such initiatives can keep the sentiment going for India even if the dollar carry trade incentive dips in the event of a US rate hike. There is, therefore, no reason for the RBI, so far committed to easy money this year, to reverse course. In any case, the inflation-output scenario underscores the need for low interest rates — a 3.6 per cent rise in the factory output index in September does not inspire confidence, while 5 per cent retail inflation in October, predictably pulses-driven, is unlikely to turn into a long-term concern.
This is not the India of mid-2013. If the Centre is able to ease supply-side bottlenecks and lift investor confidence, monetary policy can afford to focus on domestic economy concerns in a post-QE scenario, rather than worry too much about the currency. India’s chances of emerging as the favoured destination for FDI are more real than ever before, with China growing at barely 7 per cent. Finance Minister Arun Jaitley is right in acknowledging that financial turbulence has become the norm — but knee-jerk reactions are best avoided.