Decoding the Fed’s signals(thehindu)

The U.S. Federal Reserve’s widely anticipated decision to  resume its course of normalisation of monetary policy by raising the benchmark Federal Funds rate by one-quarter of a percentage point has unequivocally signalled that the world’s largest economy is well and truly back on track. Fed Chair Janet Yellen has said the U.S. central bank now expects the economy to “continue to perform well”. The median projection of real gross domestic product growth among the Federal Open Market Committee’s participants is for the expansion to accelerate to 2.1 per cent in 2017, from 1.9 per cent this year. This bodes well for the world economy as an improvement in demand for goods and services in one of the biggest markets will potentially spur economic activity all over. That the improvement in momentum has been accompanied by “solid” job gains and moderate increases in household spending is particularly heartening since personal consumption undergirds overall demand in the U.S. The Fed has also stated that it expects future interest rate increases to be gradual. The median projection for the funds rate at the end of 2017 is estimated at 1.4 per cent, indicating at most another 3 to 4 quarter point moves over the next 12 months. Such a calibrated approach to policy normalisation will allow international markets time to reset investment weights and priorities, while ensuring that the domestic momentum doesn’t unravel. And with indications that Donald Trump’s administration may unveil policies to bolster domestic economic activity, the prospects for the U.S. economy appear sanguine as of now.

From an Indian perspective, however, there are attendant risks from the Fed’s policy normalisation. For one, the dollar’s strengthening trend against most major currencies and the rupee have begun to push up India’s bill for imports — a large share of which does not lend itself to substitution — and widen the trade deficit. Latest trade data show India’s import costs in rupee terms climbed 13 per cent in November while the value in dollar terms rose 10.4 per cent, in a clear reflection of the impact of the dollar’s appreciation. Also, the very same improvement in U.S. economic outlook that could lend a glint of anticipation to Indian exporters has already been a factor in spurring an exodus of portfolio investment capital from emerging markets, including India, and inflows back into the home market. And with the U.S. President-elect resorting to protectionist rhetoric, Indian companies, especially exporters of software services, are likely to remain on tenterhooks till clarity emerges on the administration’s policy road map. For the moment, all optimism stemming from the strengthening U.S. economy will need to be tempered with caution