Assessing RBI’s Capacity to Mitigate External Risks: Is It Enough?

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There are concerns regarding the Reserve Bank of India (RBI) and the country’s overall economic environment following the US Federal Reserve’s recent move to suspend its short-term rates. Even if this progress seems encouraging, it also raises questions about the state of the global financial system.

Interest Rate Differential and Foreign Investment

With India’s benchmark rate at 6.50 percent and the US Federal Reserve’s short-term interest rate ranging from 5.25 to 5.50 percent, the difference in interest rates between the two nations has shrunk to a historically low 125 basis points. Because of this narrowing gap, global investors are less inclined to take a chance and invest in developing nations like India.

Market Uncertainty

Fund manager at Quantum Mutual Fund Ghazal Jain notes that the US Federal Reserve’s “higher for longer” policy may cause market jitters. This expression highlights the necessity of keeping inflation under control and avoiding the error of cutting rates too soon, which might increase inflationary pressures.

RBI’s Stance

According to Chief Economic Advisor (CEA) V Anantha Nageswaran, there won’t be much pressure on the RBI to tighten its monetary policy in reaction to the US Federal Reserve’s interest rate hikes. He does concede, though, that there is now less of a difference in interest rates between the two nations.

External Risks and Impact

External hazards are introduced by the US and other developed markets’ consistently increased interest rates. A stronger dollar index and rising US 10-year Treasury yields have already caused dollar funds to leave the Indian equity market. In turn, this outflow has led to the Indian rupee’s decline in value.

Moreover, rising crude oil prices exacerbate India’s economic problems; but, because state-owned oil businesses have smaller profit margins, these price increases are not instantly transferred to retail customers.

Spillover Effects and Forex Reserves

In the event that geopolitical conditions stabilise, CEA Nageswaran’s conclusion might be valid, but if the external environment keeps becoming weaker, there could be unintended consequences. India’s decision to maintain lower interest rates at the expense of the rupee’s devaluation is reflected in the country’s declining foreign exchange reserves.

Comparison with Other Central Banks

In reaction to changes in the global financial landscape, the central banks of Indonesia and the Philippines have already raised short-term interest rates. This pattern emphasises how outside influences have an impact on monetary policy choices.

Positive Aspects for India

India continues to have strong economic growth, a positive current account balance, and declining underlying inflation trends in spite of these obstacles. Additionally, the RBI has sizable foreign exchange reserves that it can use to stabilise the rupee if needed. However, if the US Federal Reserve keeps raising or maintaining high interest rates, its capacity to implement monetary policy may be limited.

Future Outlook

The US Federal Reserve did not defend its September comments, but Madhavi Arora, Lead Economist at Emkay Global Financial Services, thinks that the door is still open for more rate hikes, with a possible hike in December.

The dollar index is anticipated to trade with a bullish bias, reflecting both the likelihood of additional rate hikes by the Fed and the market’s persistent concerns over inflation, according to Motilal Oswal Financial Services’ currency research. The analysis also includes levels of resistance and support for the dollar index.

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