Fed Rates Raises – Impact On Indian Market

context

• The US Federal Reserve recently announced its fourth consecutive 75 basis point interest rate hike, raising the benchmark federal funds rate to 3.75% to 4%.
  • The US Federal Reserve is the country’s central banking system.
• The Fed also took a strong stance in favour of overtightening in order to keep inflation under control.

Relevance

GS Paper 3: Capital Market, Monetary Policy

Mains Question

What’s Operation Twist? Talk about its impact on Indian banking. (150 words)

The event

• The US Federal Reserve has raised key interest rates yet again in its fight against the country’s raging inflation.
• In its most recent monetary policy meeting, it raised the key policy rate by 75 basis points to a decade high of 3.75-4.0 percent.
• This is the fourth consecutive hike of this magnitude.

Reasons for the hike

• Inflation in the United States remains high, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures; however, the Central Bank of the United States only has tools to control the demand side, which it is using to bring inflation in line with its 2% mandate.
  • Raising interest rates is a monetary policy tool that typically helps to suppress demand in the economy, allowing the inflation rate to fall.
• According to the Fed, the fight against inflation will necessitate higher borrowing costs.

The impact of the rate hike on India

• On the RBI
  • Many analysts believe that the US Federal Reserve’s current rate hike will nudge the RBI to do the same.
  • However, this is not the case. The RBI will not follow the Fed and other central banks in raising interest rates.
• When reviewing interest rates, the RBI takes into account domestic factors, particularly retail inflation.
  • However, high imported inflation has contributed to retail inflation in India, and the RBI has already raised the repo rate by 190 basis points in the last six months.
• With the recent hike by the US Fed, there is a chance that India will import inflation, and if this occurs, the RBI will be forced to raise interest rates in India.
• On the Indian Market
  • The Fed’s continuous rate hikes do not bode well (something good is expected) for emerging markets, including India.
  • An increase in US interest rates causes an outflow of funds to US markets, putting pressure on Indian stock markets and currencies.
  • Equity markets are likely to experience increased volatility in the coming months.
• On the Indian Rupee
  • The outflow of funds from Indian markets will have an impact on the Indian rupee’s exchange rate against the US dollar.
• Since early 2022, the Indian rupee has been losing value against the US dollar.
  • A weaker rupee should benefit Indian exporters to some extent. Nonetheless, the chances of a recession in the rich world, including the United States, have increased, which will hurt them even more.