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25th March 2023 (11 Topics)

US Fed's Rates Decision & Impact

Context

The Federal Reserve Bank has raised the interest rate by 25 basis points, it sent an important signal, that the US central bank will prioritise the fight against inflation over the turmoil in the banking sector.

Why Fed has taken this step?

  • According to IFA Global, the hike was expected — as a pause would have indicated a lack of confidence in the measures taken to address the troubles in the banking system.
  • The Fed remains committed to achieving its inflation mandate.
  • The decision of the Central Bank of US, to raise the interest rate is likely to impact the banking system across world.

How fluctuating rates of Bank impact economy?

  • Impact on demand: The hikes are set to raise the lending rates in the banking system and impact the demand in the economy.
  • When interest rates are raised, it makes money more expensive, thereby resulting in reduction of demand in the economy and bringing down inflation.
  • High EMI’s: The rate hike will force banks and non-banking finance companies to increase lending rates and result in higher equated monthly instalments (EMIs) of existing borrowers.
  • New home, vehicle and personal loans will also become costlier.

What does the Fed hike mean for investors?

  • When interest rates rise in the US and other developed markets, foreign investors, especially from the US, go for investments in US debt and other avenues, which impact the flow of funds into Indian equity markets.

Since the beginning of January 2023, foreign portfolio investors (FPIs) have pulled out a net of more than Rs.27, 000 crore from Indian equities.

Will the RBI rates hike as well?

  • The Fed’s decision also indicates more rate hikes by the RBI going and subdued equity market returns for now.
  • While it is not necessary that the RBI will blindly follow the Fed and other central banks in hiking rates, interest rates in India have, in fact, moved in tandem with rates in the US.
  • While most central banks, including the RBI, have been raising rates to tame inflation, the RBI considers domestic factors, especially retail inflation, while reviewing interest rates. As price pressures wane, several central banks have opted for slower rate hikes or pauses.

Impacts on India:

  • Increasing Investor risk: While the rising interest rates represent a headwind for Indian equities, our buoyant domestic demand scenario presents hope for global investors looking to diversify globally.
  • Leads to Currency depreciation: Increase in interest rates tends to raise more for emerging markets, including India, which see sharp currency depreciation.
  • Deviation from Inflation target: Fed action is due to large excess demand, tight labour markets and an unprecedented deviation from the inflation target.
  • Nominal Policy rates: It also started from higher nominal policy rates.

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