US Fed Rate Hike ? Impact on India

US Fed Rate Hike – Impact on India
 

News: In the last week, The US Federal Reserve raised interest rates by a quarter percentage point to quell the inflationary pressures that have kept price rises well above its 2% target. The central bank also signaled a pause in further increases.
 

What is the need to resort to rate hike?

o Primary purpose is to tame inflation in the economy. Rate hike will make acquiring new loans costly thus money available for borrowing will be less which will eventually help cool down the economy.
o Less borrowing will perhaps lead to slowdown in the economic activity and growth. Business will reduce production, hire fewer people and reduce their borrowing activities.
 

Impact of US Fed Rate hike on Indian economy (General observation):

o It can also lead to a depreciation of rupee and consequent impact on India's trade balance and current account deficit.
o It can lead to a rise in interest rates in the US, which can attract capital flows from other countries. This can lead to a reduction in foreign investment in India, which will affect economic growth.
o Increase in domestic borrowing costs in India.
o Lesser demand for risky assets such as equities, which can lead to a decline in stock prices in India.
o Cost of servicing the external debt (primarily denominated in US dollars) in India will increase as the value of rupee may fall against the dollar.
 

What do experts say about immediate impact of Fed rate hikes in Indian economy?

o Experts don’t expect immediate material impact on the economy as the RBI has paused rate hikes and globally price of crude oil have also weakened.
o Domestic markets are likely to remain resilient and if there is volatility, it would have a limited impact on the economy.
o FII’s have already started investing in India.
o The current rate hike is being viewed as last one for 2023 and the Fed is expected to start cutting rates from the second half of 2023.
o If the Fed opts for a cut later in the year, capital inflows are expected to pick up and if the Fed starts cutting rates from July 2023, markets are expected to rise sharply.
 

Are there any options available for India to counter US Fed rate hikes?

o We must diversify our foreign exchange reserves to reduce its dependence on the U.S. dollar. For example, currency swap agreements, CBDC, Rupee-Ruble Agreements etc.
o Expand trade ties and network with other countries to boost its economic growth and nullify the impact of the Fed rate hikes.
o The RBI, could raise interest rates in response to the Fed hikes to attract foreign investors to invest in Indian markets, which would increase demand for Indian currency and help maintain its value.
o Reduce dependence on Crude oil – Shift to renewables, clean energy mechanisms etc
o Encourage domestic consumption through tax cuts, subsidies etc.