Unlike India, where the RBI directly tweaks the repo rate (or the interest rate at which it lends to the banking system), in the US the Fed “targets” the so-called Federal Funds Rate.
As the US heads for a presidential election in November, the Federal Reserve, the country’s central bank, has signaled that it is unwilling to let interest rates soften in a hurry. This may not just be a concern for President Joe Biden and his chances of re-election. Given that the US is the world’s largest economy and the US dollar is the most important global currency, actions of the “Fed” (as the Federal Reserve is called) are keenly watched by policymakers across the world, especially among emerging economies like India. That’s because higher interest rates in the US strengthen the dollar vis a vis other currencies, and this, in turn, incentivises investors to pull their money out of emerging economies and take it back to the US. In fact, even the mere suggestion of an interest rate hike can derail the macroeconomic stability of emerging economies, as was witnessed during the Taper Tantrum episode in 2013 when the then Fed chair, Ben Bernanke’s, hint at monetary tightening led to a flurry of capital outflows from the “fragile five” economies, which also included India.
Unlike India, where the RBI directly tweaks the repo rate (or the interest rate at which it lends to the banking system), in the US the Fed “targets” the so-called Federal Funds Rate. The FFR is the interest rate at which commercial banks borrow from each other. But the Fed can make this rate go up or down by tweaking the overall supply of money. Justifying the decision, current Fed chair Jay Powell said that the Fed does not expect it would be appropriate to reduce the target range from 5.5 per cent until it has gained greater confidence that inflation is moving sustainably to the 2 per cent target. Again, unlike India, where the RBI targets 4 per cent inflation, the Fed targets 2 per cent. In many ways, the Fed’s action is similar to the RBI’s hawkish stance. Just like the RBI, the Fed also wants to make sure that it does not reverse its policy restraint too soon lest it leads to a spike in inflation.
It is true that over the years, India’s economy has become more resilient to the actions of the Fed. The RBI has repeatedly said that its actions are independent of the Fed — that is, it can cut or raise rates even when the Fed doesn’t. Still, the Fed’s restraint gives the RBI another reason to desist from cutting domestic interest rates too soon, lest it worsens the interest rate differential between the two economies.
Click here for real-time updates on the Lok Sabha Election Results 2024
© The Indian Express Pvt Ltd
First uploaded on: 14-06-2024 at 08:34 IST
