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US Fed: Too long a breather

Aug 8, 2007

"The downside risks to growth have increased somewhat," quoted Ben Bernanke, as the US Federal Reserve maintained the short-term rates (called the federal funds rate; same as repo rate in India) at 5.25% at its monetary policy meeting yesterday. As a matter of fact, this was the ninth consecutive meeting where the Fed maintained its benchmark interest rate. The US central bank has also cited its concerns on a 'non-moderating' inflation in the economy, largely owing to record high fuel prices.Moderate economic growth and volatile financial markets also found place in the Fed's 'statement of concerns', especially considering the subprime crisis that has emanated in the US and is showing signs of spreading across the global financial markets. Bernanke has also indicated that he expects the US economy "to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy."

The US Fed continues to emit confusing signals for global central bankers, who themselves are fighting hard to defeat the specter of rising inflation levels on the back of higher crude and food prices. The Indian central bank is also toeing this line of inflation control and growth management, as seen from the rise in cost of borrowings over the past few months. Bankers however feel that this rise in interest costs has the ability to dampen the economy's growth prospects as it can slow investment and consumption demand for capital. The effect has already been seen in the April to June 2007 quarter, wherein credit growth slowed down to 24% YoY in 1QFY08 from 29% YoY levels seen in the last fiscal.

We believe that there might be a blip on the investment horizon over the next six to eight months because of the increase in interest rates over the past few months. The latest norms for external commercial borrowings (ECBs) shall compound matters further, especially for mid and small size companies who plan to raise capital for growth. This breather will help the Indian economy fare better with money flowing into potentially more viable investments against the more fickle ones.

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