How The Fed Rates Hike Can Impact India? Explained.
How the Increased US Fed Rates Will Impact India? The US Federal Reserve Bank has increased interest rates for the third time by 0.75 percentage points, bringing the federal funds rate to the range of 3.0% to 3.25% in a response to fight Inflation as it reaches its peak in 40 years. The rates are expected to increase and reach 4.4% by the end of this year in hopes of making the dollar strong.
The rising inflation in the US has already rattled its domestic economy. Additionally, it can critically impact emerging economies like India, where the capital inflow will be disrupted, and the national currency will be weakened against the strong US dollar.
What is a Strong Dollar?
The main force behind the strong dollar is the Federal Reserve Bank. When US exports are expensive to purchase in foreign markets but are cheaper to purchase in the US domestic markets, the dollar is considered to be strong.
When the Federal Reserve increases the interest rates, the dollar rises, subsequently attracting foreign investors to invest in US assets and the stock market in order to get better returns. This scenario tends to further push the dollar up in value. The fact that the US is the strongest economy in the world also affects investors' decisions. A combination of the aforementioned variables makes the strong dollar.
How Will the Increased US Fed Rates Impact India?
The US is the strongest economy in the world; naturally, when it increases interest rates, the global market is affected, including the Indian market. The hike will widen the gap in interest rates between India and the US. Therefore, foreign investors will be tempted to withdraw from Indian markets and invest in US assets because:
- India is an emerging market economy.
- The United States is a developed economy and one of the strongest economies in the world.
Another important thing to note is that increased fed rates will cause the dollar to rise up in value and the rupee to weaken in relation to the dollar. While this might not affect long-term investors, short-term investors will be put-off because of the volatility of the market and weakened rupee and hence will pull out from the Indian markets.
India is an import surplus country; that is, it imports more goods from foreign markets than it exports to them and is anticipated to experience a record-high CAD (Current Account Deficit) this year. Additionally, The Reserve Bank of India will be forced to increase rates by at least 75 basis points, as believed by economists of the country, to keep the rupee stable to ensure the interest rate differential between the US and India is maintained, which will prompt other banks to increase their interest rates, resulting in reduced demands and increased prices. The hike may result in capital flowing out of the country, perpetuating the inflation of imports, and increasing domestic rates.
While many economists believe that small inflation can be a driving factor in economic growth, this inflation can have severe ramifications on the Indian financial system.
Today, the rupee has depreciated 99 paise to close at an all-time low of 80.95 against the US dollar. Sensex and Nifty have also tanked following the Fed rates hike announcement.
Read More | US Fed Rate Hike: Impact on Indian Market, RBI Policy Stance - Explained
Read More | Federal Reserve of US increased interest rate by 0.25% for the first time since 2016.
References
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