U.S. Federal Reserve Rate Hike
- The U.S. Federal Reserve has increased its benchmark interest rate by three-quarters of a point for a fourth straight time but hinted that it could soon reduce the size of its rate hikes.
- The Fed’s move raised its key short-term rate to a range of 3.75% to 4%, its highest level in 15 years.
- Emerging economies such as India tend to have higher inflation and, thereby, higher interest rates than those in developed countries such as the US and Europe. As a result, Foreign Institutional Investors (FIIs) would want to borrow money in the US at low interest rates in dollar terms, and then invest that money in bonds of emerging countries such as India in rupee terms to earn a higher rate of interest.
- When the US 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.
- In the Indian context, net capital outflows influence the shortage of dollar liquidity, which result in rupee depreciation.
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