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Source: The post is based on the article “Will the Federal fund hike impact developing country debt?” published in The Hindu on 11th August 2023.
What is the News?
The US Federal Reserve has raised the targeted federal funds rate to 5.25-5.5%, a 25 basis points increase. This puts the rate at a 21-year high, surpassing the levels seen in 2001.
What is the Federal Funds Rate?
The Federal Funds Rate plays a crucial role in the economy as it determines lending rates among banks.
Following the global financial crisis, rates were near zero until 2015. However, since March 2022, there has been a steady increase in the rate, leading to concerns about the world economy’s ability to withstand such a sharp rise.
Why is the US Fed increasing interest rates?
Globally economies are in a recession due to high inflationary pressure. To combat this, the Fed, which is the central bank of the US, is taking aggressive steps such as an increase in interest rates (something which was not seen since the 1990s) to reduce the money supply flow in the economy.
How does Federal Funds Rate impact India?
Impact on Foreign capital: US Federal Funds rate strongly influences the foreign capital inflow in India.
When the Fed raises rates, foreign investors pull money away from emerging markets as higher rates give a boost to the dollar which erodes the shine of riskier equities.
Impact on rupee: FPIs pulling money out of the equity and bond markets could weaken the rupee even as the dollar gets stronger with the rate hike.
Highest Cost of Fund Mobilization from Overseas Markets: The rise in rates also means a higher cost of funds, and fund mobilization in overseas markets will be costly. The increase in the cost of funds may not only increase the cost of capital expenditure for India but will also strain the profit margins of companies.
Impact on Inflation: India’s inflation rate may accelerate as a result of the Fed rate hike. Depreciation of the rupee will increase the rupee cost of imported goods such as crude oil, chemicals and fertilizers, active pharmaceutical ingredients and electronics.
