In Fed rate hike news, the Federal Reserve has increased its benchmark interest rate by 0.75 percentage points, the highest since 1994. Rate increases that are too aggressive will reduce demand and slow the Indian economy. India should strengthen its macro-fundamentals and refrain from making snap decisions regarding policy in this uncertain situation. In this article, we discuss the Fed rate hike impact on India.
The threat of inflation from currency movement has increased. The cost of landing will go up due to the currency devaluation, assuming constant worldwide prices. The Fed rate was increased by 75 basis points, the largest one-time increase in nearly three decades, to between 1.5 and 1.75 percent, demonstrating the US Central Bank’s tough approach to containing inflation, which is presently running at 8.6 percent. It is obvious that additional rate increases are anticipated from the US Fed to lower retail inflation to its desired level of 2%.
In its June monetary policy, the Reserve Bank of India had hiked the short-term rates by 50 basis points to 4.90 per cent as against the inflation rate of 7.04 per cent. The RBI has a target of containing inflation at 4 per cent with an upper band of 6 per cent. While the Indian economy is relatively on a better footing than the US, the rising interest rate trajectory will have implications for the Indian economy.
Fed Rate Hike Meaning
The Fed’s intention when raising the federal funds target rate is to raise the cost of credit across the board. Everyone ends up paying more in interest since higher interest rates make loans more expensive for both firms and consumers.
Projects requiring finance are postponed by those who are unable to make the higher installments or do not want to. In order to receive larger interest payments, it concurrently pushes consumers to save money. The amount of money in circulation has decreased as a result, which tends to minimize inflation and moderate economic activity, or “cool off” the economy.
Decreasing difference in interest rates
After the 2008 global financial crisis, the US had a short-term interest rate that was almost zero until 2015. The Fed rate increased over the following five years, peaking at 2.5%, then falling to around 2% right before the COVID outbreak. In the years following COVID, the rate once more decreased to levels close to zero in order to boost the economy. Globally low interest rates helped developing nations like India draw in dollars. However, this tendency is currently turning around as the dollar is getting stronger and US Treasury yields are rising. Because the US Federal Reserve raised interest rates more quickly than India, the gap between US and Indian interest rates has shrunk recently. This would result in an increase in the movement of dollars out of India’s debt and stock markets. It is obvious that the current 75 basis point increase in the federal funds rate will reduce the appeal of the Indian market. In his monetary policy announcement, RBI Governor Shaktikanta Das did acknowledge that the “safe haven demand for the US Dollar has increased.”
Pressure on the Local Currency’s Value Relative to the US Dollar
Since January of this year, there has been a quicker rate of depreciation of the native currency. The Rupee has already lost value versus the US Dollar, falling from 74.25 in January to 78.95 today. The assistance provided by dollar inflows is progressively eroding as foreign investors keep selling shares of Indian companies without stopping. Foreign investors have already recorded a net outflow of Rs. 1.92 lakh crore in the first five months of 2022 as opposed to net positive investments of Rs. 25,752 crore for the entire year 2021. The Fed has signaled a further raise of 50 to 75 basis points at the next meeting, so the enormous selling is expected to continue. According to Federal Reserve Chairman Jerome Powell, “Inflation warranted a bigger hike today.” Additionally, the rupee’s value against the dollar is suffering due to increased crude oil prices.
Imported inflation risk
The threat of inflation from currency movement has increased. The cost of landing will go up due to the currency devaluation, assuming constant worldwide prices. However, the RBI has been intervening in the forex market to lessen volatility by using its fund of foreign exchange reserves, although the Rupee has been declining. The currency reserves have already decreased from 640 billion to 600 billion dollars. Gold, electronics, and crude oil are all major imports into India and are employed extensively in the country’s economy. In fact, the current account imbalance is already getting wider due to the increased imports (CAD). In 2022–2023, the CAD is predicted to surpass 3% of GDP. India’s macro is being impacted by the rising global rates.
To Combat Inflation, Liquidity Must be Removed More Quickly.
In order to control inflation globally, monetary policy employs the tools of liquidity and the cost of money. The cost of money weapon has already been activated by the RBI by increasing short-term interest rates, but the system still has a lot of excess liquidity. The RBI must lower the system’s liquidity levels in light of the Fed’s and other central banks’ assertive stances. It is extraordinarily high right now, with a daily cash surplus of almost Rs 7 lakh crore. The excess liquidity used to be between Rs 1-2 lakh crore in an accommodating position in normal circumstances.
During a recent press conference, Das had stated “We are completely focussed on withdrawal of accommodation. The surplus liquidity is higher than the pre-pandemic level. The liquidity withdrawal going forward would be calibrated.”. The RBI Governor has previously stated that the bank will normalize excess liquidity over the course of two to three years.
“All that we want to convey is that we do not want to take abrupt action,” Das concluded.
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FAQs
In its most aggressive move since 1994, the US Federal Reserve increased interest rates by three-quarters of a percentage point on Wednesday,15 June 2022.
The dollar is getting stronger.
What impact has this had on the rupee?
It has fallen from 74.25 in January to 78.95 to the dollar today.
The gap between US and Indian interest rates has shrunk.
