Fed Rate is the rate at which the central bank of the USA, The Federal Reserve, lends to smaller banks. On this rate, all other rate structures like auto loans, home loans, and credit card loans depend indirectly. Currently, the Fed Rate is 2.50%.
Fed increases interest rates yet again!
The Fed has increased the rates 9 times from 2015. The rates are at an all-time high after a collapse of the market in 2008. In December 2015 the Fed increased the rate for the first time form 0.25% to 0.50%. The rate was again increased in December 2016. In 2017 and 2018 the Fed increased the rates 3 and 4 times respectively.
Fed in 2008 decreased its rates to nearly 0 in order to encourage lending and spur the economy. In 2015 the Fed decided that the economy no longer needs as much help. It started raising the fed rates to make borrowing costlier. Also, the Fed is increasing rates to curb inflation. By raising the rates the US is trying to strengthen the dollar. Also, a high-interest rate can attract foreign investors looking for high-yielding returns. This increases the demand for the dollar and its value increases.
What does it mean to India?
The fed has been increasing rates since December 2015. What does it actually mean to India and Indian markets?
The Indian equity market has always given knee-jerk reactions to the Fed rate hike. Every time there is a rate hike by the Fed we see the market in red. This is due to the money outflow from Indian equities directed to the US market. The market is already volatile due to the general election 2019. This added with the rate hike pressures is highly influencing the foreign investor’s decisions. They are likely to wait to gain more clarity on the market.
US bonds are considered the safest investment option. With rate hikes, the Indian bonds are becoming less attractive. The US treasuries rising yield along with a strong dollar is reducing the gap between the yields of Indian and US bonds. This makes the Indian bonds less attractive. The investors sell their rupee investments and take back dollars to the US. This increases demand for dollar and rupee depreciates.
With every rate hike, the dollar strengthens. This is making the rupee less attractive as the investment in rupee are sold to buy dollars. The supply of rupee is more than the demand, hence depreciating it. A weaker rupee indicates costlier imports. Even though the exports of India will benefit from it, India should be able to capitalize on it. This seems a little difficult with imports being higher than exports. Costly imports would mean acquiring goods higher prices this will ultimately lead to inflation in the country.
Any monetary policy change in the US changes the global financial and liquidity conditions. This determines the foreign currency flows in emerging markets like India. This might lead India to follow a tight monetary policy by cutting down spending and increasing rates to curb inflation. But a Fed rate hike may have limited impact on the Indian economy. This is because India has been maintaining a healthy balance of foreign reserves to take care of sudden FPI outflows. It has reduced its current account deficit and fiscal deficit by a considerable level to bear the shocks. Also, India doesn’t follow fixed exchange rate system to copy US action.
Government schemes like Make In India, World Bank’s rank of ease of doing business, Indian growth rate, India’s heavy consuming population are all blessing in disguise that will help Indian economy resist the shocks and keep going.