Lower US interest rates = Good times for India?

The week that went by saw the Fed cut rates by 50 basis points, more than what anyone anticipated. That sparked off rejoicing in global and Indian equity markets, and the local benchmark, the BSE Sensex crossed the 16,000-mark. 

Some observers wondered why the markets were ignoring the fact that the Fed was obviously seeing danger signals in the US economy, which led to such a steep rate cut. But the markets were behaving as they are wont to, looking at the near term rather than worry about the future, which anyway seems uncertain. They are happy that money will slosh around again which has been one of the prime movers of equities. Understanding what it all means for the Indian economy is not easy though.

This post from Ajay Shah, a respected economist, talks about what the Fed rate implies for the world and for India. He seems to be worried about what will happen if the RBI targets the exchange rate. That seems a well-founded worry as surveys are already being bandied about, showing how exporters are worried by a rising rupee versus the dollar (see todays Hindustan Times newspaper). The rupee trades at sub-Rs 40 levels which isn’t good news for exporters who are not adequately covered. That will bring pressure on the central bank (at least that’s what we like to believe, though its a moot point whether the governor gets pressured at all) to prop up the rupee. What Mr Shah is worried about is if the RBI steps in, it will buy dollars and sell rupees, thereby lending support to a falling rupee. That has certain effects that are considered unhealthy, a few of them being more rupees flooding the market and its effect on inflation.

At a firm-level, a stronger rupee is not good for earnings for sure. Indian firms, it seems, are yet to get really comfortable with hedging risks. Having been fed on a diet of controlled exchange rates, they find the idea of paying to hedge against a rising rupee an alien concept. Most large corporate houses do protect their foreign currency exposures but do take calculated risks on how much cover to take, to lower their cost of hedging. If this is the way things are, and as this Bloomberg story says, the Fed will cut rates again in January, their problems may not go away too soon.

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