US Fed Signals Aggressive Rate Hike. How Will It Affect Indian Economy?

Aggressive rate hikes by the Federal Reserve will put more pressure on stock markets.

New Delhi:

The United States Federal Reserve raised the policy interest rate by 75 basis points on Wednesday. It was the third consecutive rate hike by the Federal Reserve since June and signaled more big hikes in the coming months.

How will the aggressive rate hike by the US Federal Reserve affect the Indian economy? There is a common saying that when America sneezes, the rest of the world catches a cold. This is evident from its impact on global equity, currency and commodity markets.

The Fed’s action has already sent global equity markets into a tailspin. Major indices of Indian equity markets fell for the third consecutive day on Thursday. The 30-stock S&PSE Sensex was down 337.06 points, or 0.57 percent, at 59,119.72. The broader Nifty 50 of the National Stock Exchange closed down 88.55 points, or 0.5 percent, at 17,629.80 points.

The Indian rupee hit a record low of 80.86 against the US dollar on Thursday after closing at 79.97 the previous day. This is the largest one-day depreciation of the rupee in seven months.

Aggressive rate hikes by the Federal Reserve will put more pressure on stock markets. When interest rates rise in the US, investors pull assets out of emerging markets. Capital is flowing more into the US economy due to higher interest rates.

The gap between interest rates in India and the US has narrowed in recent months. This is because the Federal Reserve has been more aggressive in raising interest rates than the Reserve Bank of India.

The total increase in interest rates by the Federal Reserve is 300 basis points or 3 percentage points. The Fed has raised rates by 75 basis points three times since June. On the other hand, the Reserve Bank of India (RBI) has increased the policy repo rate by 140 basis points since April.

The Board of Governors of the Federal Reserve System voted unanimously to increase the interest rate paid on reserve balances to 3.15 percent effective September 22, 2022.

In August, the RBI’s Monetary Policy Committee raised the repo rate by 50 basis points to 5.40 percent. The repo rate is the rate at which the central bank lends money to commercial banks.

So far in 2022, the RBI has hiked the policy repo rate three times. The cumulative increase is 140 basis points or 1.40 percent. The RBI first hiked the policy repo rate by 40 basis points in April and twice by 50 basis points till August.

The US Federal Reserve has also raised interest rates three times so far this year. However, the Fed has been more aggressive in raising interest rates than the RBI. The total increase in interest rates by the US Fed is 300 basis points or 3 percent.

The policy interest rate differential between the US and India, which was 3.85 percent at the beginning of the year, has narrowed to 2.25 percent.

An aggressive rate hike by the US Fed will force the RBI to hike the repo rate sharply. The Monetary Policy Committee of the RBI is scheduled to meet on September 28-30. The RBI is expected to increase the repo rate by 35 to 50 basis points later this month.

Sumant Sinha, president of industry body Assocham, said a 35-50 basis point hike in benchmark rates seems inevitable at this point given continued monetary tightening by the US Federal Reserve and other central banks.

Sinha said, “India is in a happy place with growth coming from all quarters and inflation relatively under control. Softer crude oil prices will bode well for the economy and we expect interest rates to rise from the early part of FY24.” I should start reducing,” Sinha said.

Ravindra Rao, Head of Commodity Research at Kotak Securities, said, “While the Fed has maintained a dovish stance, the steady pace of rate hikes and modest improvement in the inflationary outlook indicate that the central bank is likely to act aggressively.” There’s less pressure to do it.”

“We may see some correction in the US dollar once the central bank acknowledges the improvement in inflation conditions. Another challenge for the US dollar is with aggressive tightening by other central banks to control inflation.” There could also be possible central bank intervention to support their currencies.” Rao said.

The Indian economy is highly vulnerable to the US Federal Reserve’s interest rate action. Higher interest rates in the US will make Indian equities less attractive to foreign investors. This may lead to capital outflow from India. This will put further pressure on the Indian Rupee. A weaker rupee will make imports more expensive, further widening the current account deficit. The trade deficit may widen further. This could lead to prolonged import inflation and force the RBI to hike the policy rate aggressively.

(Other than the headline, this story has not been edited by NDTV staff and is published from a syndicated feed.)

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