Recently, it was seen that the Reserve Bank of India has taken a major decision with respect to the hiking of the rates by 35-50bps as the Central Bank will need to ensure that there is an interest rate differential between India and the US to attract dollars at such a period when our country, India will be asked to be a spectator of the record current account default. The US Federal Reserve has taken a major decision to increase the interest rate by 75% for the second straight month. Global financial conditions are also going to be in a very difficult and problematic situation in the upcoming time period.
The consequences can be very bad, such as may leading to a flight of capital flows from emerging markets just like India. This may keep the rupee volatile as well. A depreciating rupee may give a lot of stress on the inflation issue because of the higher cost of imported goods and services.
The Reason Behind The Increase In Interest Rates By The US Fed
As we all know, at a global level, the economies are in recession because of the high rate of inflation. In order to fight this issue, the Central Bank of the US which is also known as the Fed has been taking too regressive and strict steps such as increasing the interest rates in order to reduce the money supply flow in the economy of the country.
When the opinion was sought from a senior personal finance expert, she said, “A small interest rate in the economy will allow the public to opt for more and more loans with cheaper debt rates available, in order to purchase assets and also spend that money on different goods and services. That’s why the entire supply of money in circulation in the economy will increase. It may also lead to higher demand than supply. This demand-supply thing also leads to an increase in the prices of goods and services which is also called inflation.”
That’s the reason why the Central Bank took such a decision to reduce the money supply in the country’s economy and at a global level. That’s why it also resulted in a deduction in the price of goods and services. It will also control inflation.
If the interest rates are increased by the Fed, automatically, the cost of credit will rise across the economy. The higher the rate of interest, the more expensive the loans are- whether it is for business purposes or for consumers and as a result, everyone ends up spending more on interest payments. Businesses that’s why try to keep their capacity and expansion ideas on the back burner.
Impact On India’s Economy
If the policy rates are increased by the Fed, it will definitely hamper India’s policy rates. If it rises, then the conflict between the interest rates of India as well as of the US will narrow down. This will make emerging nations like India look less attractive in order to proceed with the currency-carrying business and trade. As we know, India is vulnerable to US rates. It’s better if it could result in the capital flow out of India, also create trouble for the Indian rupee further and also prolong imported inflation and also trouble more domestic rate hikes.
When asked about it by Vijay Bhambwani, head of Research Behavioral Technical analysis at Equitymaster, he said, “For growing markets in India, the US Fed hike refers to the higher probability of a rate hike in the upcoming August 5th, 2022 announcement of MPC. The borrowing cost will also increase and the rate of interest-sensitive stocks may witness some kind of margin.”
The depreciation pressure and other market currencies can be increased with the US Federal Reserve hiking rates. Further, the FII outflow with the interferences by the Reserve Bank of India is creating depletion of forex reserves as it puts pressure on the rupee. In the month of June 2022, it was seen that the Forex reserves fell to a 15-month low. Along with that, a widening of the trade deficit to an all-time high coupled with the inside risks to growth will remain the same to exert downward pressure on the rupee.
US Fed Rate Hike For RBI’s Upcoming Policy Review
The chief economist of State Bank of India Group, Mr. Soumya Kanti Ghosh also expects the RBI to raise the interest rates by 35bps by taking the interest rates to where they were before in the year 2020. This was the time when the central bank decided on the rate-cutting cycle. Another view regarding the MPC was given that it is more likely to be influenced by the outlook for the domestic inflation growth dynamics than the size of the Fed’s rate hike. If the Fed tightens the commodity prices then it may lead to a decrease in the domestic inflation reading in the MPC’s comfort level.
The principal economist of the CRISIL Research stated that a weakening rupee may give more pressure on the inflation problem through the higher rate of imported commodities and services.
The rate of hikes will purely depend on the inflation trajectory in the next half and also that how the US Fed calibrates its moves. There are many other things such as:
- The cross-border investment may also work as a barrier as it will tighten the global liquidity in many ways;
- The depreciation of the rupee is attached to the import price and growth will also be reduced to a certain extent;
- The impact on the Indian Equity market may become limited;
- The US is well-known for this but our country India is not;
- There are profitabilities of the corporate which may hit;
- The higher rate of interest in the US may have an impact on foreign investment in India;
- The fiscal is also tightened at the domestic levels;
- The debt funds will hit and it will really be beneficial for the dollar-based exporting industries.
These are the problems that will come to the forefront if the US Fed raises the interest rates and in this way, it will also have an impact on the economy of the Indian nation.