The United States’ central bank, the Federal Reserve, on Wednesday raised the policy interest rate by 75 basis points. This is the third straight interest rate hike by the Federal Reserve since June and has signaled a bigger hike 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, currencies and commodity markets.
The Fed’s action has already triggered global equity markets. Major indices of the Indian stock market fell for the third consecutive day on Thursday. The 30-stock S&P BSE Sensex slipped 337.06 points, or 0.57 per cent, to 59,119.72. The Nifty 50 of the National Stock Exchange fell 88.55 points, or 0.5 per cent, to end at 17,629.80.
The Indian rupee on Thursday slipped to a low of 80.86 against the US dollar, as against the previous day’s closing at 79.97. This is the biggest one-day fall in the value of the rupee in seven months.
Aggressive rate hikes by the Federal Reserve will put further pressure on the stock markets. When interest rates rise in the US, investors pull assets away from emerging markets. Higher interest rates lead to more capital inflows into the US economy.
The gap between interest rates in India and the United States 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 cumulative increase in the interest rate by the Federal Reserve is 300 basis points, or 3 percentage points. The Fed has hiked the rate 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 from April.
The Board of Governors of the Federal Reserve System voted unanimously to raise the interest rate on the reserve balance to 3.15 percent with effect from September 22, 2022.
In August, RBI’s Monetary Policy Committee raised the repo rate by 50 basis points to 5.40 per cent. Repo rate is the rate at which the central bank lends money to commercial banks.
So far in 2022, RBI has increased the policy repo rate three times. The cumulative increase is 140 basis points, or 1.40 percent. RBI had raised the policy repo rate by 40 basis points for the first time in April and by August it was increased twice by 50 basis points.
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 cumulative interest rate hike by the US Fed is 300 basis points, or 3 percent.
The policy interest rate gap between the US and India, which stood at 3.85 per cent at the beginning of the year, has now come down to 2.25 per cent.
Aggressive rate hike by US Fed will force RBI to sharply hike repo rate by RBI. RBI’s Monetary Policy Committee meeting is scheduled to take place from 28-30 September. RBI is widely expected to hike the repo rate by 35 to 50 basis points later this month.
Industry body Assocham President Sumant Sinha said an increase in benchmark rates by 35-50 basis points seems inevitable at this juncture, given the continued monetary tightening by the US Federal Reserve and other central banks.
Sinha said, “India is in a sweet spot with growth from all quarters and inflation is relatively under control. Moderation in crude oil prices will be good for the economy and we should start the interest rate cut cycle from the early part of FY24.” should do.”
Ravindra Rao, Head of Commodity Research at Kotak Securities, said, “While the Fed has maintained a firm stance, the steady pace of rate hikes and a modest improvement in inflationary conditions suggest that the central bank has the potential to act aggressively. The pressure is low.”
“We may see some correction in the US dollar once the central bank accepts an improvement in inflation conditions. Another challenge for the US dollar is by other central banks to control inflation as well as support their currencies. There could be aggressive tightening by potential central bank interventions.” Rao said.
The Indian economy is highly sensitive to interest rate action by the US Federal Reserve. Higher interest rates in the US would make Indian stocks less attractive to foreign investors. This can lead to an outflow of capital from India. This will put further pressure on the Indian rupee. A weak rupee will make imports costlier, further widening the current account deficit. The trade deficit may widen further. This could lead to prolonged imported inflation, forcing the RBI to go for aggressive policy rate hikes.
(Except for the title, this story has not been edited by NDTV staff and is published from a syndicated feed.)