Will US Fed Rate Hike Devaluate The Indian Rupee?
The prospect of a rate hike by Fed in its next FOMC Federal Open Market Committee meeting to be held on 17th
September at Washington DC is most likely, after the July
job reports have indicated a robust growth. The Federal
Reserve was expected to raise the Fed Funds rate by 25 bsp
or basis points at the FOMC meeting on 28th July. However
it did not, since the financial markets were yet to attain
stability after Brexit.
Once the Fed raises the Fed Funds rate, it shall probably go
up by 0.25 per cent at first and later on rise not beyond 2 per cent, since inflation is no more
a threat. Turbulence might be felt in emerging markets like South Africa, India, Turkey
Brazil, etc. where the local currencies will be weakened against the dollar. Now, there is
possibility of knee-jerk reactions amongst the domestic traders and investors to begin with,
followed by a dip in the Sensex and the value of rupee, as trade commences in domestic
markets on Friday.
What happens to the Indian rupee if the Fed hikes rates?
If the Fed hikes rates, a few of the foreign investors are anticipated to book profit of their
Indian holdings of bonds and shares. They might send home funds back to the US, where
buying high interest rate bearing bonds shall be attractive. Also, they might offload masala
bonds over US bonds. Selling by foreign investors leaves a great impact on Nifty and Sensex
since they own shares in the blue chip segment, which comprises close to 25 per cent of the
BSE, as per a recent report.
The Fed has spoken about raising rates for atleast a year. In response, we expect the value of
dollar to rise. Further, strengthening of the US dollar shall hurt American exports more and
slower their economic growth and shall create lower import prices, thereby reducing
inflation.
Fed shall definitely raise interest rates to search a way out of a possible liquidity trap while
the same in India shall mean a weaker rupee culminating into a fat import bill. India is a
trade deficit country and the outflow in the form of debt and equity selling can put pressure
on the Indian rupee. Also, India is already importing 80 per cent of oil to fulfill its fuel needs.
Indias CPI or consumer price index has its major component as fuel and if the countrys
import bill rises, it is feared inflation rate might also gallop up. Now, the Indian rupee could
hit a low of 66 to 66.46 as against 66.73. Earlier in August, it had shed 4 per cent since
August to 66.46 from 64.13 already and had rebound after correction.
Whats happening in India?
India doesnt have a fixed exchange rate anymore. Rupees international value is determined
in the foreign exchange market. The RBI intervenes whenever there is volatility. The
Narendra Modi government is considering to setting up a committee to determine the fair
value of the Indian currency. This is not a feasible idea as times have drastically changed and
we are not living in 1991, and definitely not in 1966.
Rupee devaluation kick-off in 1966:
For the first two decades after independence, India had a constant peg against dollar at
Rs.4.75/dollar. However, 4th June, 1966, saw the first major devaluation. India was in a
wobbly, unsteady state as it had just fought 2 major wars with Pakistan and China and had a
swapping of 3 Prime Ministers (Nehru, Shastri, Indira) in a span of 3 years after 17 long years
of one man rule. This was followed by a major drought which shook the country to the roots.
In the 1966 Budget the Indian government announced a massive depreciation of 57 per cent
of the rupee overnight from Rs.4.75/dollar to Rs.7.5/dollar.
Energy crisis and gold sky-high prices of 1980s:
From 1966 to the year 1980, rupee maintained status quo. The year 1979 brought along with
it the energy crisis and gold's sky-high prices in early 1980s which left the nation cornered
since oil and gold were historically Indias primary imports. Indian rupee began to decline
gradually. From about 7.85/dollar in 1980 it slumped to about 17/dollar by 1991.
The nightmare of July 1991:
India was hit by another major crisis in July 1991. In layman terms, rupee was overnight
devalued by another 50 per cent from about 17/dollar to about 25/dollar.
Liberalization in 1993 followed by the Asian crisis of 1997:
Indian Finance Minister allowed rupee to float a bit freely in the 1993 liberalization. The
rupee was set free to be traded by traders without a compelled peg. Since the government
was no longer controlling the prices fully, rupee slid to 35/dollar by 1997.
The year 1997 was no boon either as the Asian continent was hit by a financial crisis.
Investors were quitting Asia enmasse which devalued rupee further from 35/dollar to
39/dollar.
Pokhran- II bombarded Indian rupee:
In 1998, Indian Prime Minster announced the nuclear testing (Pokhran-II). Immediately
countries like US, Japan and others imposed sanctions on India, limiting investments. In a
mere span of two months, rupee tanked to 43/dollar and in 2002 reached at Rs.48/dollar.
The rainbow of hope:
All of a sudden light was seen at the end of the cave for 7 years from 2000 to 2007. Rupee
started recovering and began moving up and reached about 39/dollar by the year 2007.
Shit hits the fan:
Happiness sadly came with an expiry date and shit hit the fan- the financial crisis of 2007
08. This caused the investors to retreat from all emerging markets, including India which
dragged the rupee from 39/dollar to 51/dollar by March 2009. In the next 2 years however,
rupee recovered a great deal due to economic optimism and rebound in the US markets.
The European sovereign-debt crisis:
Jinxed as rupee was, European sovereign-debt crisis hit the world in 2011. Another reason
was Indian government's budget positions getting worse because of profligate overspending.
The rupee doomed from 44/dollar in August 2011 to about 56/dollar by June 2012.
Conclusion:
The effect of a rate hike in the US on India shall be confined due to strong fundamentals as a
tidy repo rate structure, inflation targeting and airtight money control by the RBI. The novel
tax reform is a big revenue boost and a novel engine of growth to act as a firewall against all
possible global impacts such as Brexit, Fed rate hikes, oil prices and so on and so forth.
We just have to now wait and watch how the Fed's announcement impacts the Dalal Street.
Something or the other will keep popping up on the horizon like Fed rate hike, devaluation
by China, oil prices. But the only ray of hope is that India will strike its own balance under
the prevailing global economic conditions.
Disclaimer
The investment advice or guidance provided by way of recommendations, reports or other ways are solely the personal views of
the research team. Users are advised to use the data for the purpose of information and rely on their own judgment while making
investment decision.
Dynamic Equities Pvt. Ltd - SEBI Investment Advisory Reg. No.: INA300002022
Disclosure
Dynamic Equities Pvt. Ltd. is a member of NSE, BSE, MCX SX and a DP with NSDL & CDSL. It is also engaged in Investment
Advisory Services and Portfolio Management Services. Dynamic Commodities Pvt. Ltd., associate company, is a member of MCX &
NCDEX. We declare that our activities were neither suspended nor we have defaulted with any stock exchange authority with
whom we are registered. SEBI, Exchanges and Depositories have conducted the routine inspection and based on their
observations have issued advise letters or levied minor penalty on for certain operational deviations.
Answers to the Best of our knowledge and belief of Dynamic/ its Associates/ Research Analyst: DYNAMIC/its Associates/
Research Analyst/ his Relative:
Do not have any financial interest / any actual/beneficial ownership in the subject company.
Do not have any other material conflict of interest at the time of publication of the research report
Have not received any compensation from the subject company in the past twelve months
Have not managed or co-managed public offering of securities for the subject company.
Have not received any compensation for brokerage services or any products / services or any compensation or other
benefits from the subject company, nor engaged in market making activity for the subject company
Have not served as an officer, director or employee of the subject company
Article Written by
Salman Hashmi
