In the more recent of its monetary policy reviews, the U.S. Federal Reserve declared its decision to keep policy rates unaltered. This decision was rooted in the continued progression of the country’s economy, a robust labour market, and forecasted inflation rise.
The Relevance of Federal Reserve’s Decision
The decisions taken by the Federal Reserve, whether it’s rate hikes or delivering hawkish messaging, are not just influential on the U.S. economy. These policies also play a crucial role in forming the macroeconomic perspective and controlling the monetary strategies in emerging economies. For instance, this unchanged stance by the Fed has had an effect, albeit indirect, on the Reserve Bank of India’s (RBI) Monetary Policy Committee’s decision to increase the repo rate by 25 basis points in March 2019. This hike signifies a reversal from the lenient monetary policy that India had been following for the preceding three years.
Why Do U.S.A. Fed Rates Affect Emerging Economies?
Emerging economies like India generally exhibit higher inflation rates and interest rates compared to developed countries such as the U.S. and Western European nations. Because of this, foreign institutional investors (FIIs) may prefer to borrow money at lower interest rates from the U.S. and then invest that money in government bonds of emerging countries like India where they can earn a higher rate of interest. However, when the U.S. Federal Reserve increases its domestic interest rates, the interest rate difference between the two countries narrows making currency carry trade less appealing in India. As a result, capital may flow back out of the Indian markets and into the U.S., causing a decrease in the value of the Indian currency against the U.S. dollar.
| Indicator | Value |
|---|---|
| Repo rate hike by RBI in March 2019 | 25 basis points |
| Outflows from Indian markets in the previous year | Over 40,000 crore rupees |
What Is the Impact of Increased Interest Rates on India?
Increased interest rates have various implications for the economy of India.
On Equity Market
Bond yields are likely to increase due to a rising dollar shortage in the global market. In the previous year, both the debt and equity markets in India saw outflows amounting to over 40,000 crore rupees. This was largely due to the strengthening dollar and uncertainties arising from the trade war involving the U.S., China, European Union, and other prominent countries.
On Export and Forex
India, being one of the biggest importers of crude oil globally, will experience costlier imports due to a weaker rupee in relation to the dollar. This could lead to an inflationary trend across the entire economy, especially impacting the sectors that are strongly affected by changes in crude oil prices. Conversely, exports – particularly IT and IT-enabled services – may garner some benefits from a stronger dollar as compared to the rupee. However, this benefit may not be fully realized due to intense competition in the export market.
