Interest rate hike

Updated December 03, 2018


THE markets were undoubtedly taken aback on Friday when the State Bank announced a hike of 150 basis points in the key policy discount rate.

All expectations in the run-up to the announcement had hovered between 50 and 100bps, and it would be fair to say that hardly anybody expected a jump this big.

This is the single-largest hike in the key interest rate since the cycle of monetary tightening began in January this year. What makes the rate hike even more interesting is the volatile backdrop provided by the currency markets while the board meeting was under way and the decision under discussion.

It is a curious coincidence that the silent supports provided to the exchange rate were withdrawn on the very morning the board was to sit down to discuss the rate hike, and the markets gyrated as a background score to the discussions.

It is difficult to know how these two events might be connected, but there is one obvious link: an overvalued exchange rate necessarily calls for higher interest, else the economy risks running aground.

We may never know for certain whether or not the two events — the rate hike and the rupee depreciation — were directly linked. But we know that speculative forces have been stoked by both events.

The markets have seen that the dollar can find buyers even at Rs145, and the business community now knows that interest rates might well be venturing deeper into double-digit territory in 2019.

Both cases work against a favourable investment environment.

As such, these events will serve as brakes on the growth rate, and play their part in fulfilling the very forecast that the State Bank itself advanced in the monetary policy statement — that the economy is set to see a “notable moderation” in the remaining months of the fiscal year.

These are the beginnings of a large-scale stabilisation exercise that the government has to undertake sooner or later, and the deeper implications for growth and investment are now acquiring sharper focus.

The path forward, therefore, needs to also become clearer in the weeks ahead, as the combined impact of further depreciations and rate hikes could well trigger the very speculative forces that the bank is trying to contain.

These gyrations are not healthy and an unambiguous course of action needs to come into view soon.

Published in Dawn, December 3rd, 2018