- 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.
GS Paper 3: Capital Market, Monetary Policy
What’s Operation Twist? Talk about its impact on Indian banking. (150 words)
- 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.