The US Federal Reserve raised interest rates by 75 basis points or 0.75 percentage points, the biggest hike in 28 years.
Details –
- The US Federal Reserve has hiked the key interest rate by 75 bps to a range of 1.5%-1.75% and said it is “strongly committed” to bring inflation to two percent.
- The decision to increase the rate by 75 bps — the biggest since 1994 — comes days after the retail inflation in the country surged to 8.6 percent in May, the highest since 1981, as energy and food costs surged.
- When rate hike by US Federal Reserve leads to foreign Institutional Investors (FIIs) cashing out from Indian Stock Markets, as Indian markets would become less attractive to them.
- Net foreign fund outflow from India in 2022 has crossed the Rs 2 lakh crore mark, the biggest annual figure ever and more than double the previous high of Rs 80,917 crore recorded in 2018.
- Of the total, over 90%, or about Rs 1.9 lakh crore, was because of selling by foreign portfolio investors (FPIs) in the stock market.
- The FPI outflow could continue for a few more months, at least till the time there is clarity about how far the US Fed will move to tighten liquidity in the US.
About US Federal Reserve –
- The Federal Reserve System is the central bank of the United States.
- It was founded by the US Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system.
- The Board of Governors, located in Washington, D.C., provides the leadership for the System.
- The chairman and vice-chairman are appointed by the US President for four-year terms.
Why US Fed Rate Changes Impact Indian Markets?
- US is an already developed nation with limited growth possibilities. On the other hand, India is still a developing economy with massive growth opportunities. Hence, interest rates in India are much more flexible than in the US.
- So what foreign investors do is that they borrow heavily in the US and infuse that capital in the Indian market where interest rates are high.
- This significantly reduces their borrowing costs, which could have been higher if they resorted to borrowing the same capital in the Indian financial markets.
Impact of Rise in the US Fed Interest Rates –
- Not just India, markets globally are affected when the interest rates are hiked in the US. There is a popular quote in world affairs which says “when America sneezes, the world catches a cold.”
- Rate hikes result in foreign Institutional Investors (FIIs) cashing out from Indian Stock Markets, as Indian markets would become less attractive to them. The rate hike also positively impacts US treasuries’ yield, which motivates foreign investors to pull their money out of the Indian markets and invest it in their own country.
- An increase in interest rates would result in a weaker Indian Rupee in comparison to the USD. This would again bring foreign investors lower returns on their investments.
- Though foreign investors with a long-term horizon will not panic with marginal rate hikes, small-terms investors will indeed back off because volatility in the market coupled with a weaker rupee requires hedging the positions, cutting short the returns.
Impact of cuts in the US Fed Interest Rates –
- Developing economies like India will benefit from rate cuts because foreign investors will be attracted towards the high returns the Indian economy promises, and inflation is not a significant concern.
- A rate cut in the US Fed interest rates is a positive cue for the Indian markets as it would drive fresh foreign investors to the markets.
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