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Business News/ Markets / How does the interest rate hike by US Fed impact the Indian markets? An explainer

How does the interest rate hike by US Fed impact the Indian markets? An explainer

The US Fed raised interest rates for eleventh time in its past 12 meetings. The higher rates are likely to impact equity markets everywhere including India.

 Amid the higher interest rate scenario, the capital deployed in emerging markets is likely to decline Premium
Amid the higher interest rate scenario, the capital deployed in emerging markets is likely to decline

The US Federal Reserve on Wednesday raised interest rates by 25 basis points. This was the eleventh raise in its 12 meetings. Now the interest rates are hovering around their 22-year-high.

Post-hike, the overnight interest rate has been set in the 5.25 - 5.5 percent range.

The Fed Reserve chief Jerome Powell said interest rates will not be lowered, at least this year, since the central bank has yet not achieved its inflation target of 2 percent.

Impact on Indian markets

The US Federal Reserve’s increase in interest rate usually impacts equity markets around the world. Any major tweak in the interest rates tends to sway the markets in one direction or the other.

This is how it works.

Indian markets tend to receive a sizable inflow of capital from foreign institutional investors (FIIs), particularly from the US. For instance, in the June quarter, India received FII inflow of $1,220 crore towards equity, shows one report.

And one of the key reasons for the deployment of foreign capital is lower interest rates charged by US banks. Needless to mention that there are other reasons as well such as performance of equities in the Indian markets.

And when these rates are raised by the US Fed, the cost of capital rises upward, thus disincentivizing overseas investors to borrow more capital in the US in order to invest in emerging markets including India.

Besides, higher interest rates make the US dollar stronger, which further dissuades the FIIs to invest in emerging markets.

However, the ongoing rate hikes by the Fed Reserve are not expected to impact Indian markets, at least not significantly – believe experts.

Chokkalingam G, Founder, Equinomics Research & Advisory, says, “There would not be much impact (of Fed rate hike) on equities as Indian markets have given a solid wealth creation story. Besides, when the impact on Indian equities was not significant when the rates were raised from zero to 5 percent, what difference can we expect by another 25-basis point hike."

About the expectations of further rate hikes, he says that the chances of more rate hikes are grim since the inflation in the US — even if not under control — has at least moderated and is not expected to rise further.

“No analyst will tell you that the inflation will zoom and the interest rates will rise to 7 or 8 percent," he adds.

“We don't anticipate major impact on the equity markets as foreign inflows primarily are happening as a result of India's strong GDP numbers. However, there could be a marginal impact on equity if the US Fed continues to lower interest rates since the lower rates are good for economic growth," says Ravi Saraogi, Co-founder, Samasthiti Advisors.

“From the interest rate’s point of view, there could be some impact on India. There was a sentiment that interest rates in India -- after having peaked -- will now reverse. But with the US Fed continually decreasing interest rates, RBI will be under too much pressure not to lower its rates too much to avoid exerting pressure on exchange rate," adds Saraogi.

To sum up, inflow and outflow of foreign capital is a function of numerous factors and higher interest rates in the US is one key factor.

But when other determinants are tilted in favour of Indian markets, one factor may not necessarily play a spoilsport.

Impact of interest rate changes on bond prices.
View Full Image
Impact of interest rate changes on bond prices.

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Published: 27 Jul 2023, 03:43 PM IST
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