In a major move that could bolster the investor sentiment in the developed countries, the US Federal Reserve hiked the benchmark short-term interest rates by 0.25 percent. This has been done for the first time in over seven years after the 2008 financial crisis had forced the US Central Bank to make the interest rates at zero to ease the liquidity crunch.
The interest hike has raised concerns in the emerging markets and as expected India is no exception to it. While some analysts say that India was prepared for the rate hike, others say it is still likely to impact the markets at least in the short-term. A frequently asked question by the common citizen is how the US Fed rate hike impacts India. The reason is not all that esoteric: developed countries offer better returns to investors and the US Government bonds are considered to be the safest instruments of investment with assured returns.
Impact on capital markets in India
The Fed rate hike will ensure the return of investors to the US as the economy is on a steady footing and many Foreign Institutional Investors (FII) are expected to pull out from emerging markets including India. The flight of capital will lead to more selling in the markets. FIIs have already taken out more than Rs 14,000 crore from the Indian markets as of November. Investors had invested in India and other emerging markets in the past seven years as the returns offered in US were negligible for investors due to zero-interest rates, while the emerging markets promised higher returns. However, the volatility in emerging markets has always kept investors on their toes.
Impact on Rupee
The hike in interest rates will strengthen the US dollar, as the US markets would give better returns. This will hurt the Indian rupee further as the currency has already been depreciating due to falling exports in the recent past. The rupee touched 67 to a dollar mid-December reaching a two-year low. India will now have to shell out more on imports due to a stronger dollar and this could hit the finances of the country in the short-term.
Higher cost of imports could increase inflationary pressures as more rupees in the market will lead to increased money circulation. The consumer price index, a measure of inflation, is hovering around 5.41 percent and if the rate exceeds 6 percent, it could dent the capacity of the RBI to reduce interest rates further for the industry.
Foreign exchange woes
To arrest the already declining rupee, RBI has been selling foreign exchange and the diminishing rate hike would further weaken the rupee, putting pressure on India’s Central Bank to sell more dollars than it would want to.
Some of the other tangible impacts on Indian economy could include a fall in profitability of companies as rupee depreciates. Studying abroad and foreign travel would also become expensive, and debt will become more expensive as companies that borrowed dollars will have to pay more.
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