US Fed rate hike pause: impact on India

US Fed rate hike pause: impact on India

Subject : Economy

Section: External Sector

Context: Federal Reserve has maintained the policy rate, after continuously raising for 15 months

Key Points:

• Federal Open Market Committee (FOMC) has decided to pause the cycle of interest rate hikes despite inflation being at 4%
• The benchmark rate (Fed Rate) continues to be 1%
• Fed has signalled that it could increase rates again by the end of 2023 as the inflation target of 2% is yet to be achieved.
• The pause along with a signal of future increase is seen as a hawkish (monetary tightening) stance.
• The decision is supported by the US Inflation at 4% is being below its interest rates of 5.1% (i.e. real interest rates being positive)
  • if inflation is higher than interest rate in an economy, it means the real interest rate is negative
  • Negative interest rates while encouraging investment by increasing the cost of parking funds in banks, also have the effect of discouraging savings.
• Likely impact on Indian economy/market:
  • Is likely to have a negative effect on the Indian equity markets for two reasons:
    • Reduced inflow: a rise in interest rates in the US reduces inflow of funds into markets
    • Outflow: outflow from emerging markets to US treasury bonds.
  • The pause (and not reduction) in the Fed rate is indicative of inflationary pressures still being present in global markets.
    • India too may see continuation of the inflationary cycle.
    • RBI too may thus not reduce interest rates in near term.
  • In the short term WPI will reduce through a reduction in prices of commodities, especially oil.