What’s in the news?

• The Fed is widely expected to cut interest rates for the second time this year.

What happens when the US Fed increases interest rates?

• When the US Federal Reserve (Fed) increases its interest rates, the difference between the interest rates of the two countries reduces (known as interest rate differential), thus making India less attractive for foreign investors. 
• It results in outflow of foreign investments from India and other emerging economies.
  • As investors pull out money, the demand for the US dollar increases, causing the Indian rupee to weaken.
  • A weaker rupee increases the cost of imports like crude oil, contributing to inflationary pressures in India.
  • Higher US rates make it more expensive for Indian companies with dollar-denominated debt to repay loans, impacting their balance sheets.
  • Global investors rebalancing their portfolios in response to Fed rate hikes can lead to volatility in Indian stock markets.

When US Fed reduces interest rates

• Similarly, when the US Federal Reserve decreases its interest rates, the interest rate differential widens resulting in capital inflows into emerging markets like India, as investors seek higher returns.
• Increased capital inflows can lead to an appreciation of the Indian rupee, making imports cheaper and reducing inflationary pressures.