scorecardresearch
How US Federal Reserve’s 50-bps rate hike is likely to impact Indian financial markets

How US Federal Reserve’s 50-bps rate hike is likely to impact Indian financial markets

As expected, the US Fed also announced a 50-basis point increase in its short-term Fed rate to 0.75 to 1.0 per cent late Wednesday night.

US Federal Reserve announces rate hike US Federal Reserve announces rate hike

It happened all in a single day. While all eyes were on the US Federal Reserve to deliver a hefty 50 basis points hike in its short-term interest rates late in the night, the Reserve Bank of India (RBI) Governor Shaktikanta Das stunned everyone by giving out a 40 basis points hike in repo rate to 4.40 per cent. As expected, the US Fed also announced a 50-basis point increase in its short-term Fed rate to 0.75 to 1.0 per cent late Wednesday night, as well as a plan to begin reducing its $9 trillion balance sheet starting next month. Both the central bankers took action to fight the inflationary pressure post the Russia -Ukraine conflict. The likely impact of the US Fed is going to be much more detrimental to emerging markets like India. Let's take a look: 

Hasten the dollar outflow from emerging markets like India

Foreign investors have pulled out a massive Rs 1.22 lakh crore from the Indian equity and debt markets in the year 2021-22. In the current fiscal 2022-23, global investors have already made a net sale of equity and debt to the tune of Rs 25,594 crore in the month of April alone. The dollar outflow is definitely going to accelerate as the bond yields in the US market begin to offer a better return with safety. The dollar outflows will weaken Indian financial markets.

Higher import cost to widen current account deficit  

India historically runs a trade deficit. As trade is normalising in the post pandemic period, the trade deficit has been widening as imports have been higher than exports. According to Acuité Ratings the cumulative trade deficit for 2021-22 has widened to more than a decade high at $192 billion. It was in 2012-13 when the trade deficit peaked at $190 billion. Given the higher crude prices , Acuité Ratings expects the trade deficit to widen further. A higher trade deficit will put pressure on the current account deficit (CAD), which in turn will increase demand for foreign currency, especially dollars, to finance the deficit.

Pressure on currency value against the US dollar

The Indian rupee was at Rs 73 against the US dollar in January this year. But the tide has completely turned after the Russia-Ukraine conflict. The rupee is now trading at 76.35 per dollar, a sharp depreciation of 4.58 per cent in a short period of time. The country's foreign exchange reserves, which had been rising in the past, peaked in September at $642 billion. The forex reserves have been on the decline since foreign investors started pulling out money from India over the concerns of higher global inflation. The current level of India's forex reserves is around $600 billion. This indicates the RBI's intervention in the forex market to reduce volatility.

Domestic inflation and interest rates

Domestic inflation will be driven up by the imported inflation coming from the higher global commodity prices and also the currency depreciation. There is now a threat of imported inflation as currency is likely to depreciate more. Domestic retail inflation, or CPI actually ended the March month at 6.95 per cent. The inflation target for RBI is 4 per cent with a band of 2 to 6 per cent.  In its April policy, the RBI raised its forecast for inflation from 4.5 per cent to 5.7 per cent for the whole year 2022–23. The RBI Governor today said that the MPC expects inflation to rule at elevated levels, warranting resolute and calibrated steps to anchor inflation expectations and contain second round effects. The RBI has already acted today by increasing the repo rate by 40 basis points to 4.40 per cent.

Also read: RBI Guv Das announces hike in interest rate by 40 bps to 4.40% in 'off-cycle' MPC meet

Also read: Fed hikes rates by half percentage point to contain inflation

Published on: May 05, 2022, 7:30 AM IST
Posted by: anwesha madhukalya, May 05, 2022, 7:23 AM IST