Impact Of The US Federal Reserve Rate Hike On The Indian & Global Economy

The US Federal Reserve Open Market Committee raised its funds rate by a quarter percentage point to a target range of 5.25%-5.5%. When the US Federal Reserve raises interest also called the federal funds rate, it acts as a reference for the interest rates big commercial banks charge each other for overnight loans.

This means if the US Fed raises the interest rates, borrowing of loans for commercial banks from each other becomes more expensive. In India, when interest rates are raised by the RBI, commercial banks have to borrow money from the RBI at higher interest rates.

Impact of the US Federal Reserve rate hike on the Indian economy

When the US Federal Reserve hike interest rates, there are worries that it could slow economic growth in the US, as borrowings become costlier. When the US economy slows it tends to impact Indian IT companies first. Already, we are seeing a slowdown for the IT sector in India and quarterly results by companies like Tech Mahindra and Infosys have not been good.

The other impact that happens is that interest rates on Sovereign Bonds move higher in the US and hence Foreign Portfolio Investors may sell stocks in India and invest in US Bonds. Let's explain this a bit. Foreign Portfolio Investors are foreign investors registered by the Securities and Exchange Board of India who invest in Indian stocks.

When interest rates go higher, they get good interest rates from the safe interest bearing instruments like US Sovereign Bonds. So, they might sell Indian stocks and buy government bonds in the US. However, if the rate hike was anticipated then there is not much bearing on the stock markets. There could be some bearing also on the currency, if the hike is not anticipated, in a sense that the rupee could become weaker.

Impact on the global economy

Apart from this, it could have some bearing on the global economy, as the US is the world's largest economy. Presently, there are worries that a hike in the US Federal Reserve interest rates could slow economic growth worldwide and lead to a recession. What happens when interest rates go higher is that borrowing costs increase.

So, a person who has loans, including mortgage loans would now have less money in hand. This leads to lower spending, which tends to reduce inflation and may in the medium term lead to a recession. So, a more direct impact of an ongoing interest rate hikes is a slower economy and possibly a recession. An ongoing series of hikes can also have an adverse impact on the stock markets as investors would move money away from stocks, which tend to offer more risk, to the safer government bonds.

A rise in interest rates also affects commodities like gold, where individuals and investors take shelter in safe government bonds by selling into gold.

"The US Fed hiking rates by 25 bps were on expected lines, the street is expecting one more hike from here on. As inflation is showing signs of control an impending fear of recession will limit Fed's ability to hike rates further. Globally, gold prices are expected to touch the $2000/oz level. Domestically, the rate may touch its previous high of over 62,000/10gm. The movement of the yellow metal will largely be guided by the economic data in the west, and the magnitude of the recession in the US," says Colin Shah on Gold price outlook post-Fed rate hike.

Conclusion

To conclude, a hike in interest rates may slow the global economy, impact currencies and lower gold prices as well, while making certificates of deposits and fixed deposits more atrractive.