How Interest Rates in US impacts India

Source- This post on How Interest Rates in US impacts India has been created based on the article “India to face most impact if high U.S. interest rates persist” published in “The Hindu” on 12 April 2024.

Why in the news?

The US Federal Reserve has decided to hike interest rates that will impact the Indian economy.

How Interest Rates in US impact India

1) With the U.S. Federal Reserve and the European Central Bank maintainig ‘higher for longer’ interest rates, the consequent strength of the U.S. dollar and the euro leads to an initial depreciation of emerging economies’ currencies, including the Indian rupee.

2)  The depreciation of the rupee directly affects India’s import, increasing the prices of imported goods, particularly oil and other commodities that are crucial for India’s economy.

This would add approximately 0.4 percentage points to India’s inflation through 2024 and 2025 which would exacerbating the cost of living and production costs within the country.

3) As per ADB’s projections, India’s GDP growth may slow slightly (by under 0.2 percentage points in 2025) compared to baseline projections. This is partly due to increased costs of borrowing and investments, as global capital shifts towards higher yielding U.S. assets, reducing the amount of foreign investment flowing into emerging markets like India.

d) On the positive side, a weaker rupee could make Indian exports more competitive on the global market, potentially boosting export volumes. This could add about 0.05 percentage points to India’s GDP growth this year.

However, this effect might reverse in 2025 and 2026 as global monetary conditions stabilize and the rupee potentially strengthens, making exports less competitive again.

e) Higher interest rates in the U.S. could lead to a wider gap between U.S. and Indian interest rates, affecting the flow of capital. India might have to increase its own interest rates to manage inflation and prevent further depreciation of the rupee, which could have its own set of consequences on the domestic economy.

UPSC Syllabus: Economy