ETMarkets Smart Talk: Rupee under pressure, inflation sticky: Will RBI be forced to rethink rates? Ankita Pathak, Ionic Asset

The US Fed may have raised rates by 25 basis points, but for India, the bigger worry could be what comes next.

With the rupee under pressure, inflation showing signs of broadening and the dollar and US bond yields staying elevated, the RBI could find its room for an independent monetary policy getting increasingly limited.

So, does India need to prepare for another rate hike? How much pressure could a stronger dollar put on Indian equities and the rupee? And with US 10-year yields at around 5%, do global investors now have a more attractive alternative to emerging markets?


In this edition of ETMarkets Smart Talk, Ankita Pathak, Head – Global Investments, Ionic Asset, shares her views on the Fed’s tightening cycle, the RBI’s policy dilemma, the outlook for the rupee and what the evolving global macro landscape means for Indian investors. Edited Excerpts –

Q) The Fed has raised rates by 25 bps, but markets were largely expecting it. What does it mean for Indian markets?

A) Markets did expect it, and that makes this particular 25 bps largely a non-event for equities in general. What matters more is what follows. Continued rate hikes, and inflation that fails to recede, will have larger repercussions for EM equities and commodities.

Domestically, the picture has shifted since the last policy. The RBI Governor had highlighted then that inflationary pressures were largely concentrated in food and fuel, with no clear signs of a broad-based uptick.

Since then, headline inflation has moved from 4.38% in June to 4.82% in August, and core inflation has risen to 4.2%. In my view, price pressures are now becoming broader.

The rupee still hasn't stabilised despite the RBI measures announced on June 5. With inflation showing persistence at home, and the Fed and other global central banks now actively responding to energy-driven inflation, the RBI faces a genuine dilemma between growth, inflation and currency stability in the upcoming policy.

With the Fed now in a tightening regime, the possibility of the MPC considering a rate hike has increased. India does need monetary reflation, but one hike can be absorbed — growth shows no imminent signs of stress, so the cost of acting now is low.

Q) For Indian equities, should investors be more worried about the Fed itself or the resulting move in US bond yields and the dollar?

A) The move in US bond yields and the USD matters more than the Fed decision itself. A stronger DXY following a Fed hike is a headwind for EM assets in general, because higher US yields pull capital out of riskier EM economies and back into US assets.

Having said that, the sustainability of USD strength is the key question right now.

Continued monetary policy tightening by the BoJ and ECB, along with the ongoing UST sell-off, could limit the upside in the USD, and therefore the pressure on Indian equities and EMs more broadly. And de-dollarisation continues to brew under the surface.

Q) If the Fed delivers another rate hike this year, what could that mean for global risk assets, emerging markets and capital flows?

A) If the Fed delivers another hike and the USD is able to sustain its strength, it may be negative for global risk assets, EMs and the commodities trade. However, USD strength may not be sustainable in the current scenario.

Tightening by the BoJ and ECB, along with the UST sell-off, could cap the dollar, which in turn limits the pressure on EMs and global risk assets.

Q) What does the Fed's latest move mean for the RBI? Does India have enough room to pursue an independent monetary policy?

A) If the RBI holds rates at current levels, it may face two key risks: one, further depreciation in the INR, and two, higher imported inflation.

An independent stance would therefore put additional pressure on the rupee, with repercussions for inflation and the external account, which eventually weigh on domestic growth.

So, while the RBI does have room to pursue an independent policy, the current global rate environment may make that flexibility a lot more constrained than it was six months ago.

Q) Does a higher-rate environment make US fixed income more compelling for global investors compared with the previous decade of ultra-low yields?

A) On carry, yes. US rates have moved up sharply, with the 10Y UST now at 5% — up roughly 100 bps over the past year and the highest since 2007. Real yields have also improved materially compared with the previous decade.

But there are no capital gains to be made. High fiscal deficits mean duration can remain under stress and may not correct meaningfully, and US fixed income has become highly volatile in the past couple of years. Therefore, allocation towards it may not be preferred at the current juncture.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)