The US Federal Reserve on Wednesday increased policy rates by 75 basis points to tame inflation which hit a four-decadal high of 8.6% in May on continuing supply-side disruptions emanated from the Russia-Ukraine war.
Following the latest rate hike, the Fed’s funds rate now stands at 1.5-1.75%, and a further 175 bps increase is anticipated in the year to bring inflation within the central bank’s 2% long-term objective. This is the third rate increase by the US Fed. The Fed first started hiking the rates back in March, when it increased the policy rates by 25 bps; this was followed by a 50 bps rate hike in April, and now this 75 bps increase in June. The US Fed also revised lower its FY23 GDP growth forecast to 1.7% from previously 2.8%. ETCFO discussed with economists the implications of the US Fed’s actions on the Indian economy.
Implications for India
The US Fed increase will likely impact India in two ways, said Madan Sabnavis, Chief Economist, Bank of Baroda. First, it will encourage the foreign institutional investors to continue their sell-off, which could see benchmark indices coming under pressure further, and second, it will continue to weigh on the Indian rupee, he said.
Also, he does not foresee any recession in the US on account of these ongoing and further rate hikes, arguing that the central banks across the world, including the Fed, are unlikely to take off their eyes from growth and they would be sensible enough to not let economies slip into contraction.
“The US Fed rate hike was on expected lines. The message is clear from their central bank they are keen to fight inflation. Higher interest rates will mean that Foreign Institutional Investors (FIIs) will have a tendency to continue in investment opportunities in the US itself. Also, currency volatility will likely continue back home,” Sabnavis said.
As far as the impact on India’s monetary policy is concerned, Sabnvais said, the RBI is unlikely to be dictated by the US Fed, saying that it would track its own domestic retail inflation to decide on the future course of the interest rates.
Swati Arora, economist, HDFC Bank, echoed a similar narrative. She said that the US Fed Rate increasing rates as much as 75 bps is coming on the back of continuing high inflation. “…The market earlier was expecting that inflation had peaked in April at 8.3% and was expecting May inflation print unchanged at 8.3% and about a 50 bps rate hike. However, the May inflation print showed that it further rose to 8.6% instead and this seems to have prompted the US Fed to hike rates by 75 bps,” she said.
Arora expects India’s Central Bank, RBI, to also hike rates in its next August policy meeting. She said that while inflation in India during May eased to 7.04% and came off from an eight-year high of 7.8% in April, the trajectory however, needs to be carefully watched over the coming months.
“May inflation mainly came down on the back of base effect and excise cuts in fuel announced in the last week of May. The impact of these measures will be entirely reflected in June inflation print,” she said.
The economist expects retail inflation to remain above 7% until Sep/Oct 2022 led by higher food and crude prices and elevated services inflation. Besides, the measures taken by the government to tame inflation could be offset if the oil marketing companies (OMCs) start increasing their prices in the light of high under-recoveries, a move which they have refrained from so far. “
Rising inflationary pressures are likely to further prompt the Central Bank to increase rates when it next meets in August….I foresee interest rates to end somewhere close to 6% by FY22 end,” she signed off.
Interest rates in India currently stand at 4.9%. After maintaining a pause for over two years, the Indian Central Bank started increasing the rates in April. The RBI has so far increased the rates by a total of 90 bps (40 bps increase in unscheduled May meeting followed by 50 bps increase in June meeting). The RBI sees FY23 growth at 7.2%.