US Financial Crisis, the rising interest rates and its Impact on India
A lot of talk has been going on about US interest rates. Let’s begin by understanding the crux of the situation that is what has happened and why is it is happening. Interests rates are charged on any borrowings made and are generally represented as a percentage of the loan. In order to ensure price stability in an economy a country’s central bank performs the duty of setting base interest rates and other lenders peg their interest rates to those set by the central government.
The United States follows Federal system of government in which power is shared between central (referred to as Federal) and State Governments. The Feds are contemplating on increasing their interest rate for the first time in 9 years where the last interest rate was raised in the year 2006. The US Fed’s interest rate has been almost zero for years and now an increase is expected. One of the reasons as to why the Feds are intended towards raising the interest rates is that there has been an increase in unemployment in US and the total unemployment percentage has fallen to 5.1% in the month of August 2015. The second reason being the dip in the inflation rate by 0.1% can prove to be fatal in future. So in order to keep a check on both the unemployment prevailing in the country as well as declining inflation rates the US feds have to monitor them with the help of interest rates. However, the recent scenarios which is happening in China that is the stock market plunge as well as devaluation of currency added to the overall health of the economy has made US to wait a little longer to change the rates.
Now let’s look at the impact of the increase in Interest rate in India. There are possibilities that in a few days India would be cutting its rate by 0.25% and US raising theirs by .25%. As mentioned before the current interest rate at USA is almost zero and a rise from .1% to .25% implies the new rate is more than double the old rate. Invariably after three months it would further increase by 0.25% after three months and led to further doubling. The price of bonds is inversely related to interest rates. It means that bond prices can crash up to 50% every time the interest rate is going to double. This implies a 0.25% hike in the US can critically matter. Apart from nearly zero rates in the US, those investors who save in Switzerland, Germany and Japan would be forced to leave their home markets and plunge into riskier countries like China and India.
In case the Fed decides to raise interest and reach up to 2%, then there are possibilities that trillions of dollars could flow back to the US from all developing markets which would lead to Indian Stock market to crash down. It is observed that in the previous month when rumours spread about the interest rate hike has caused turmoil in the emerging markets. So, an increase in interest in US rates of 0.25 % can set off a series of events.
Analyzing the change in interest rate in India in depth we can see that many US companies borrow at 2 % today, so an raise of 0.25% implies a substantial rise of 1/8th overall. However the leading Indian companies borrow either between the ranges 8-9% or 12-14%, so this increase doesn’t make much difference to these borrowers. On the other hand smaller companies have very little or no formal banks backing them and it’s the RBI which finalizes decisions on the interest rates. From the total costs on average costs for companies, interest costs account to merely 3% and the fact is the domestic business are affected more by global conditions and fiscal conditions rather than interest rates.
So the question in mind is that does this change in interest rate make much of a difference to India? There has been so much hype about the interest rate by the media which is made to highlight the annual budget coverage. Also the media pertaining to financial media only cater to those in the bond markets like banks and traders. This small change in the interest rate would matter to EMI’s of interest loans charged for cars and houses of middle class section of the society.