US Fed Raises Interest Rates - Effects on India


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.

On Dec 16, 2015, the US Federal Reserve has raised interest rates by 0.25 percentage points - its first increase since 2006. The move takes the range of rates banks offer to lend to each other overnight - the Federal Funds rate - to between 0.25% and 0.5%. The move is likely to cause ripples around the world, and could increase pressure on the European economy to raise rates. It could also mean higher borrowing costs for developing economies, many of which are already seeing slow growth. Rates in the US have been at near-zero since 2008. There are concerns that a rise will compound that slowdown, as higher rates in the US could strengthen the dollar, the currency in which many countries and companies borrow. It puts US policy at odds with that in Europe, where even easier borrowing terms are being implemented. The European Central Bank earlier this month cut overnight deposit rates from minus 0.2% to minus 0.3% and extended a €60bn stimulus programme.
Following the 2008 financial crisis, US economy reduced their interest rate to zero. This was done so that businessmen could take loans from US banks at zero interest rate and invest in business. This would help in the growth of the US economy.
But when the interest rate is low, other countries would not invest in US. This is because they would not get higher returns (interest rate is the return). Therefore other countries who were not investing in US, started investing in India. This was because India was relatively unaffected by the global crisis. Investment in India was done in the form of FDI or FII.
Impact on India:
1 ) Much of what happens in India will depend on how foreign institutional investors (FIIs) react to the Fed hike. FIIs have withdrawn nearly $2.5 billion from domestic markets since November in anticipation of a hike. Now that the actual announcement has come, things are likely to calm down, analysts say. "Just like how the quantitative easing tapering news was more potent than the actual tapering, markets will self-adjust once the rate hike is announced as this news gets factored in.
2) The Fed's rate hike is based on the belief that the US economy is doing well. Faster growth in US - the world's biggest economy - augurs well for India. Economic Affairs Secretary Shaktikanta Das said that the recovery in US economy will especially be beneficial for domestic IT companies.
3) Domestic stock markets and currency have been nervous in the run-up to the Fed's announcement; the broader Sensex and Nifty hit three-month lows last week, while the rupee sank below 67/dollar to a 25-month low earlier this week. However, markets as well as rupee have rebounded this week as a 25-basis point Fed rate hike got factored in.
Care Ratings expects the rupee to showcase a pullback towards 66 per dollar, citing the stability in balance of payments.
4) This would make investing in US economy profitable once again. The countries which invested in India earlier, would divert their capital to US. This would negatively affect India since, given the financial constraints, India is dependent on foreign capital. Indian investment would fall and hence growth would be affected.

Thursday, 17th Dec 2015, 06:05:47 AM

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