What is the issue?
- U.S. Federal Reserve again raised its benchmark short-term interest rate by 25 basis points to 1.75%, the highest in a decade.
- This monetary tightening is driven by the confidence in the markets, but there are inherent risks which call for caution.
What is the trend in US monetary policy?
- The 2008 economic crisis pushed central banks worldwide to cut interest rates to historic lows in order to overcome recession.
- These loans were facilitated by public borrowings and monetary policy easing and hence had to be serviced at some point in the future.
- So, US Federal Reserve (which control’s monetary policy), has been tapering liquidity lately, as the US economy seems to have recovered fully.
- While the current increase is only the 6th since the financial crisis of 2008, the trend ahead seems unambiguous for further increases.
- Notably, US economy is projected to register strong growth ahead.
- The resultant inflationary pressures might push Fed rates further for the next 2 years.
How has its impact been?
- To reverse the post-2008 liquidity easing, the Fed and other central banks have initiated normalisation of monetary policy.
- The impact of these on the wider credit markets is slowly beginning to show in the markets.
- The “interbank lending market” has been directly influenced.
- Significantly, the benchmark “London Interbank Offered Rate” (LIBOR), at which international banks lend to each other has also been increasing.
- LIBOR has risen for more than 30 consecutive sessions and is currently at its highest since the financial crisis.
- Also, the corporate debt market has clearly been impacted.
- The rising rates could adversely affect the capacity of private firms to service their debt.
What are the challenges?
- Debt Default - The risk of default by private borrowers has been flagged by various organisations recently, including the IMF.
- Notably, private corporations attracted by ultra-low interest rates had heavily loaded up on debt over the last decade.
- Also, some companies borrowed heavily from across the borders, thus making them prone to exchange rate risks as well.
- Ironically, the 2004-2006 period saw the Fed raising rates to tackle inflation.
- But it ultimately led to a mass default of mortgage debt and precipitated the 2008 crisis.
- Trade Protectionism - US President Trump’s steep tariff raise against imports from China had recently forced down stock values across markets.
- These trade wars will clearly have a negative impact on global growth.
- Corporate earnings and these policy uncertainties seem to be a long haul.
- Capital Flux - Rising interest rates would also see capital outflow from emerging markets due to liquidity crunches.
- This is particularly a concern for India.
Source: The Hindu
