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Federal Reserve’s stance and India

  • IASbaba
  • September 24, 2021
  • 0
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INTERNATIONAL/ ECONOMY

  • GS-2: GS-2: Effect of policies and politics of developed and developing countries on India’s interests 
  • GS-3: Economy & its challenges.

Federal Reserve’s stance and India

Context: Recently, US central bank (Federal Reserve) has reiterated that it would maintain an ‘accommodative stance’ until inflation and employment targets had been met.

What is accommodative stance?

  • An accommodative stance means that there is room for lowering interest rates in the future to revive growth and demand in the economy.
  • Accommodative monetary policy, also known as loose credit or easy monetary policy, occurs when a central bank attempts to expand the overall money supply to boost the economy when growth is slowing (as measured by GDP).
  • The policy is implemented to allow the money supply to rise in line with national income and the demand for money.

What did the Federal Reserve say?

  • US Fed outlined the risks to economic outlook due to pandemic and said it would continue to “maintain an accommodative stance of monetary policy” until it achieves an inflation moderately above 2 per cent.
  • The Federal Open Market Committee (FOMC), which sets US monetary policy, has decided to keep the target range for the federal funds rate (equivalent to India’s Repo rate) at 0 to 0.25 per cent

What did the Fed say on the infusion of liquidity?

  • The Fed had said in earlier (July 2021) that it would moderate (slowdown) the pace of asset purchases.
    • Purchasing bonds/asset by Central Bank means infusion of money supply into the market i.e. increase in liquidity. The Fed currently purchases treasury securities of at least $80 billion, and mortgage-backed securities of at least $40 billion per month.
    • Excess liquidity in US market has been channelized worldwide into other emerging markets as well. 
    • Low interest rates & high liquidity in the US will ensure continued fund flows from foreign portfolio investors (FPIs) into Indian equities. FPI flows into Indian equities amounted to Rs 2,083 crore in August 2021.
    • Slowdown in asset purchases (also known as tapering) means slowing of liquidity infusion by US Fed.
  • In its recent meeting, US Federal Reserve indicated that the tapering (slowing down) of its bond purchase programme would be gradual and spread into the middle of 2022.

What does the Fed’s decision mean?

  • Asset purchases could decline by $15 billion per month, and an end to asset purchases by mid-2022 will strengthen the case for raising rates in 2023.
  • This is seen as a sign of strength that the US economic recovery is on the right path. 
  • Analysts say the tapering (slowdown of bond purchases) is likely to be calibrated, and non-disruptive for financial markets — which means foreign investors are unlikely to suddenly exit India. 
  • US putting stringent conditions with respect to inflation and employment for a rate increase & tapering means that there is predictability in Fed’s functioning.

What is the future outlook?

  • There is a consensus among participants that domestic markets, like that in India, will ride more on local factors going forward. 
  • There is hope that faster vaccination will result in a milder third wave of Covid if it strikes, and that the economy will witness further reopening and faster consumption-driven growth.
  • Consumption is expected to increase closer to Diwali, and credit growth will see a pick-up over the next two months

Connecting the dots:

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