Vashistha Ray
Would Federal Reserve, the central bank of the U.S, raise
its policy rate sooner than expected? This is difficult to answer and no
unanimity can be reached on this. Some believe that time is not ripe enough for
the Fed to execute the rate-hike and it would hold on till September; while others
find it imminent.
The rate-hike expectation led stock markets across Asia to
crash on Monday. The expectation of rate-hike gained momentum after the latest
data from the U.S last week showed that unemployment rate had fallen to 5.5%
which is the lowest since May 2008. A selling- spree of stocks was seen following
this report which resulted in tumbling of markets across Asia.
Indonesia’s Jakarta Composite, Taiwan’s Taiex and South
Korea’s Kospi each declined by 1%. Benchmark indices of Indian stock market also
fell by 2.1%. The 30-share Sensex lost 604.17 points to close at 28,844.78
while the broader Nifty declined 181 points to 8756.75. Monday fall was the
highest in Indian stock market Since January 6.
The expectation –led crash of stock markets left the policy
makers off- guard and they could do little to salvage the market. However, the
development has sent a note of caution to them. They are now discussing a
course of action that could be taken to protect the economy and market when
expectation of rate-hike materializes and consequent capital flight to the U.S
from Asian countries starts. The Governor of R.B.I Raghu Ram Rajan has also
expressed his concern over this issue.
To what extent the
fear or expectation of rate-hike by the Fed is justified?
Most of the major economies of
the world such as Euro-zone, Japan and China are in recession. They are
implementing expansionary monetary policy to spur growth and employment. The European
Central Bank launched its pre-announced Quantitative-Easing (QE) program
whereby it intends to purchase government bonds of euro-zone countries worth 60
billion euro each month. The exercise would continue till September,2016 when
the target of bond purchase worth 1.1 trillion euro is achieved. Interest rate
in Japan is already near zero per cent and it further intends to ease money
supply in order to tackle its long-drawn recession. Chinese economy is also in
trouble. Employment, export, and aggregate demand are sagging. Sentiments of
investors are gloomy. People’s Bank Of China has thus decided for a monetary
easing. Besides these economies, policy rate cut has been seen in various
countries of the globe including India, Australia and Indonesia in recent past.
In such a time when the U.S economy
is surrounded by a host of under-performing economies, any decision with regard
to rate-hike may spell trouble for the economy. The move would appreciate the
already over-valued greenback and raise the prices of American goods and
services relative to her trade-partners. This would leave American goods less
competitive in world market. With her trade-deficit rising each year, the U.S
could ill-afford to hike the rate.
The major deterrent could be from
‘new normal’ of china which shifts focus of the government to structural reforms
from growth. Apart from the largest exporter of the world, China is also the second
largest importer country. It imports most of the services from the U.S economy.
‘New normal’ of china would sufficiently reduce its quantum of imports from the
US. If the greenback further shot-up against Yuan following rate –hike by the US,
China may be triggered to spur its service industry to replace imported services
from the US.
So, external economic reasons may
dissuade the Fed at this juncture to take this critical decision of rate-hike. However,
the Fed may not work purely on external considerations. It has equally strong
and valid domestic reasons to raise the rate sooner than later. The latest job
data released by the US last week shows that unemployment in US has fallen to
5.5% which is the lowest since May, 2008. The Fed has expressed satisfaction at
this rate of unemployment and with rising employment; it is fast loosing its
ground for holding policy rate near zero percent. So far as recession in other countries
is concerned, the US may ignore it before taking the decision of rate-hike. This
is so because the US is self-contained and relatively a closed economy and only
30% of its GDP consists of foreign trade.
Most of the members of Monetary
Policy Committee of The Federal Reserve, which decides about the policy rate, have
articulated their views in favour of rate-hike. The Fed Governor MS. Janet who
has till now been showing a ‘patience approach’ would find it difficult not to succumb
to the pressure of other members of the committee when it meets to decide about
a much-awaited rate- cut.
