The US Federal Reserve hiked interest rates in the US for the first time since June 2006. The benchmark interest rate has been raised between 0.25 per cent and 0.50 per cent, marking the end of free money.
"The US economy has shown considerable strength. Domestic spending has continued to hold up, " Janet Yellen, US Fed Chairperson said.
Outflows of capital
A hike in interest rates is not always good news for equities. While the initial 25 basis point by the US Fed is not a worry, subsequent hikes at a more rapid pace could be a disaster for Indian stocks. This is because Indian stock markets are heavily owned by Foreign Portfolio Investors (FPIs) and further hikes may result in selling pressure.
This is because foreign investors would start chasing higher yields in the US, which are risk free. While investing in Indian equities, they remain exposed to a high degree of currency risk.
These FPIs have also invested staggering amounts in Indian debt as well. By March 2015, the amount invested in government debt was in excess of $24.5 billion.
A hike in US interest rates tends to strengthen the dollar against major currencies. The Indian currency will also get weak, unless there is RBI intervention. We wish to reiterate once again, that the real impact will be felt only if there are a few more interest rate hikes that happen by the US Fed. Also, outflow through FPIs can impact the Indian rupee.
Cost of foreign borrowings
With interest rates moving higher, companies that are borrowing from the overseas market are likely to find it more expensive. Already, they are exposed to foreign currency risks and now higher interest rates will start to creep in.
There is unlikely to be a major impact on the Indian stock and currency market this morning, when they open for trade. The real impact could come one year down the line, if there are as many 4 quarter per cent hikes.But, that again would depend on economic data coming out of the US, including employment and inflation.