US Fed Rate Hike

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Context

The Federal Reserve began raising rates in March last year (2022) and has consistently pushed the federal funds rate since.

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https://www.iasgyan.in/rstv/us-fed-rate

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Spillover effects on India

The Reserve Bank of India (RBI) is also forced to keep up with the Fed and raise rates. The reason for this is twofold:
1. A significant enough interest rate disparity would lead to a depreciating currency making imports expensive and leading to runaway inflation.
2. India faces an inflationary problem of its own and requires rate increases regardless of the actions of the Federal Reserve.
Banks’ lending rates must rise to keep up with the RBI to maintain their net interest margin.
Increase in Interest rates leads to increase in EMIs. The State Bank of India has consistently raised its teaser housing loan rate from a low of 6.75% during 2021 to 8.5% as of March 2023.
Interest rate increase signals wage decreases and impending job losses.
Therefore, it is difficult for those with EMIs to continue to maintain their standard of living in current times.
When the Fed raises its policy rates, the difference between the interest rates of India and and the US narrows. This making emerging countries such as India less attractive for the currency carry trade. And since India is vulnerable to US rates, it could lead to capital flow out of India, depress the Indian rupee further, prolong imported inflation and prompt more domestic rate hikes.
When the US Fed hikes interest rates, capital flows more towards the US economy and takes risk assets away from emerging economies like India. And this leads to higher cost of capital, and a re-pricing of risk.
FII outflows along with the intervention by the RBI causes depletion of forex reserves adding pressure on rupee.

MAINS PRACTICE QUESTION

Q. The US Federal Reserve’s mission is to keep the U.S. economy humming—not too hot, not too cold, but just right. However, the US Fed rate hikes have spill-over effects. How the US Fed rate hike impacts the Indian economy? Explain.

https://www.thehindu.com/business/federal-reserve-delivers-small-rate-hike-amid-recent-financial-turmoil-in-us/article66650683.ece