In a decision that will have far reaching impact on countries across the world, the US central bank Federal Reserve has increased its lending rate by an unprecedented 0.75 per cent — the steepest hike since 1994. It also pledged to do everything to tame inflation, even if it means slowing down the economy. The Federal Reserve is also expected to increase the rate by 0.5 or 0.75 per cent in its July meeting to bring down its inflation to two per cent.
While the focus of the Federal Reserve is its domestic priorities, the decision will an adverse impact on the economies of several countries, including India. A higher rate on US treasury bonds will make many emerging markets unattractive for global investors and slow down the flow of investment. While the return of investors to the US treasuries would make the greenback stronger, the flight of capital would shake the fundamentals of many small economies.
The Federal Reserve’s decision would exert pressure on Indian rupee as it will slow down the portfolio investments. While it could lead to correction in stock markets, if domestic investors do not step in to support the valuations, it could also force the Reserve Bank of India, which has already taken the stance of monetary tightening, to further increase repo rates. Any weakening in the rupee will have a ripple effect on the price of imported goods. While it could reduce the demand for some of the imported goods, the price-inelastic goods like petrol, diesel and natural gas will become costly and feed into the prices of other commodities. The costly fuel could further increase inflationary pressures. There is no easy way to protect global monetary tightening. India must increase exports and reduce its dependence on hot money that flows into stock markets and debt markets.
