Federal Reserve signals and Indian markets

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  • GS-2: Effect of policies and politics of developed and developing countries on India’s interests
  • GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment. 

Federal Reserve signals and Indian markets

Context: US Federal Reserve indicated that there could be two rate hikes by 2023. 

After this announcement, in India, the benchmark Sensex fell marginally and the rupee lost over 1% against the dollar

What did the Federal Reserve say?

  • US Federal Reserve maintained that they would continue with an accommodative monetary policy and bond buying programme to support the economy, generate employment and achieve inflation of around 2%.
  • At the same time, they discussed the rate hike and an eventual reduction, or tapering, of the central bank’s bond buying programme. This was a deviation from its March announcement. 
    • In March 2021, the Fed signalled that they would hold the rates near zero through 2023.
  • Some members were also in favour of raising rates at least once in 2022. 
  • The Federal Reserve noted that the progress on vaccinations has reduced the spread of Covid-19 in USA and with strong policy support the fundamentals of the economy has strengthened necessitating rate hike.

How did the markets react?

  • A hike in interest rates in the US has a bearing on the debt and equity markets, not just in the US but also in emerging economies.
    • India had witnessed record foreign portfolio investments (FPI) over the last one year due to easy monetary policy of US Federal Reserve. Investors could get easy loans & pump it into emerging markets for quick returns.
  • After the Fed’s signalling, the Dow Jones Industrial fell 265 points and the treasury yield rose from 1.498% to 1.569%. 
  • In India, the benchmark Sensex fell 461 points or 0.87% and the rupee lost 75 paisa or 1% against the dollar.

What could be the impact of an early hike in interest rates?

  • News of a hike in interest rate in the US leads not only to an outflow of funds from equities into US treasury bonds, but also to an outflow of funds from emerging economies to the US.
  • The rupee is also expected to come under pressure as the dollar strengthens.
  • After June witnessed FPI inflows of Rs 14,500 crore into Indian capital markets, it remains to be seen if there is a slowdown in the pace of inflow over the coming weeks and months

What are domestic concerns for India?

  • Wholesale inflation has been rising for five months, and is expected to rise further as the impact of high crude prices and surging commodity prices feed in due to weakened rupee.
  • In India, an ebbing of the second wave of the pandemic and increasing vaccination numbers have led to expectations of a recovery in demand, and higher raw material prices. This would cause retail inflation to rise as well.
  • Both wholesale & retain inflation puts the RBI on a tightrope walk in balancing the growth-inflation dynamics.
  • Meanwhile, as there is no further scope for a rate cut by RBI, all eyes are on the government for fiscal policy action to spur growth.

Connecting the dots:

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