What difference do two words make?
Apparently, quite a lot.
The US Federal Reserve meeting was being closely monitored to see whether it would change the pledge to keep interest rates low for a “considerable time”. Removing “those two critical words would indicate its intention to hike interest rates in the near future.
But the Fed maintained its commitment to keeping the policy rates low for a “considerable time”, even as it gradually halts its massive Quantitative Easing (QE) program that was launched in the aftermath of the financial crisis in 2008 next month.
However, the so-called dot plots, which are basically projections of what officials expect the federal funds rate to be, showed that a sharper rise is in the offing compared to the June projections. The officials now expect the federal funds rate to be between 1.25% and 1.50% in late 2015 and between 2.75% and 3.0% in late 2016.
Although Fed Chair Janet Yellen said at a press conference following the policy meeting that there is no fixed mechanical interpretation of a time period and that it is highly conditional and is linked to the committee’s assessment of the economy, it is possible that the Fed is preparing the market for a change in language in its October policy
On the impact of higher US interest rates on India, there are competing views.
One view holds that an increase in the US rates and a reduction in Indian rates, both expected next year, will lower the interest rate differential between US and Indian yields, triggering capital outflows. As US securities will appear more attractive, there will be a global portfolio reallocation which will lead to outflows from India and other emerging markets.
The competing view holds that although the Fed is winding down its liquidity programme, it will be countered by an expansion from the European Central Bank (ECB) and the Bank of Japan (BOJ), which will probably balance it out for India. Latest reports indicate that China has also taken measures to boost liquidity, although the scale of its operations will probably be smaller. The ECB has already cut interest rates earlier this month, pushed by fears of a EU-wide slowdown because of lower German growth rates.
In the past, countries that have suffered on account of QE taper talks were ones that tended to have high current-account and fiscal deficits coupled with high inflation. Although India was a poster-boy for this phenomenon, having fared miserably on all three indicators, considerable progress has been made since then. Growth, although sluggish, is likely to have bottomed out. Inflation is trending down and the current account deficit has narrowed. In addition, the new government has reaffirmed its commitment to containing fiscal deficit.
So it’s possible that India may be now in a better position to deal with the withdrawal of the massive US liquidity programme. This time could be different.
(Ishan Bakshi covers national economy and policy issues)