FPI withdraw funds from India as US Fed, ECB hike rates

FPI withdraw funds from India as US Fed, ECB hike rates

Subject:Economy

Section: External sector

In News: FPIs pull out over $1 bn from India in 7 days in view of rate hike by US Fed and ECB

Key Points:

• With interest rates hike in developed markets like the US and the Euro zone, foreign portfolio investors (FPIs) who were big investors have started pulling out funds from the Indian market.
• The selling started after the US Federal Reserve, hiked the interest rates by 25 per cent last week amid indications that higher inflation is likely to linger longer even though the Fed had already covered a lot of ground to bring interest rates to a two-decade high.
• The European Central Bank (ECB) also announced a new rate increase of a quarter percentage point, bringing its main rate to 3.75 per cent.
• Why do US interest rates affect the Indian stock market?
  • When interest rates rise in the US and Europe, the yield (return) on their domestic bonds (treasury bills) increases.
  • As a result foreign investors prefer to invest in their domestic markets instead of diverting funds to emerging markets like India.
  • Further there is also an overall negative outlook towards world growth when major economies increase interest rates, this is reflected in lower valuations of companies, including those of emerging markets.
• Will RBI also increase rate?
  • When the Fed increases rate, the interest rates for emerging markets tend to rise more. This is because of the currency depreciation that accompanies outflow of international money.
  • As a result the central banks of emerging market countries also have to increase the interest rate to stabilise the exchange rate.
  • It does not mean that RBI will blindly follow the Fed in hiking rates, although interest rates in India have, in fact, moved in tandem with rates in the US.
  • For the RBI, primary objective is to tame inflation, the RBI considers domestic factors, especially retail inflation, while reviewing interest rates. Thus the decision to increase rates will be taken  after considering all factors.
• Another hike by the Fed is on the cards and we will have to wait till the September policy meet before which the Fed will see how incoming data on inflation and labour market pans out