Here’s why the US is increasing interest rates and how it impacts Indian markets

Here’s why the US is increasing interest rates and how it impacts Indian markets
  • For the past several months, Indian stock markets have been falling worrying about potential rising interest rates in the US. What’s the connection?
  • Not only India, many global markets have also been witnessing weakness, expecting the US administration to increase interest rates.
  • Foreign investors have been pulling out funds from the country leading to market fall, but why? Let’s understand the real reason.
In the last six months, Indian benchmark index Sensex has slipped over 7%, witnessing huge swings and one of the reasons you may have heard is because of fear of the US Fed raising interest rates after months of quantitative easing.

Not only the Indian bourses, but stock markets across the globe have witnessed weakness in the past couple of months due to this fear.

Why are markets fearing interest rate hikes in the US?

One thing that is impacting almost every other country across the world is high inflation.

Inflation refers to a rise in the prices of most essential goods and services like food, clothing, housing, transport, consumer staples, etc.

It all started with the COVID-19 pandemic that shook the world, with countries around the world shutting down activities to curb the spread of the infection. Millions of employees were laid off as companies could not survive because of no movement of goods leading to disruption in the supply chains.

Consumer demand at the same time remained very high and as supply side struggled, there was an increase in prices of essential commodities. While the inflation was already high in many countries another event hit the world this year – Russia’s invasion of Ukraine.

The war led to huge supply disruption in Russia, which is one of the largest producers of cooking oil, crude oil, minerals, metals, wheat, and many other commodities.

Now, consumers around the world are paying higher prices for basic necessities like food, oil, and gas as Russia’s war on Ukraine disrupted supply chains with oil and food exports facing a crunch due to sanctions imposed by the West.

How to control rising inflation?

Many major economies across the world are grappling with rising inflation – the list includes the US, Japan, Australia, and major European countries like Germany, France and Italy, among others.

Because of high inflation, the US central bank has been looking to stop measures for economic stimulus – also known as quantitative easing – that began after the pandemic.

One way to do it is by increasing interest rates.

Why is the US increasing interest rates?

The idea behind rising interest rates is that it will make borrowing costs higher, which can then slow down inflation and cool off demand.

Simply put, higher loan costs will directly impact purchasing power meaning less people would be able to buy houses, cars, and even businesses would find it difficult to expand. All this will eventually cool demand and subsequently, inflation.

Why is the Indian stock market suffering because of the hike in US interest rates?

Rise in the US interest rates does not bode well for the Indian markets, as it can lead to foreign investors pulling their money out from emerging markets like India back to the safe and secure markets in the US.

So far in 2022, foreign investors have pulled out ₹1.14 lakh crore from equity and debt markets.

At a time when interest rates are rising in the US market, foreign institutional investors (FIIs) find it safer and more attractive to invest in the US debt market rather than going elsewhere (like in risky emerging markets like India).

In the meantime, Indian currency continues to depreciate with concerns around crude oil and global inflation. It now stands at ₹76 per dollar falling from ₹74 last year. A falling rupee affects foreign investors as it decreases their earnings. For instance, a foreign investor who had invested ₹1 lakh at ₹74 per dollar in an equity fund would have had to invest $1,351. Now with the rupee depreciation at ₹76, the value of the investor’s investment has fallen to $1,315.

All this is because of the COVID-19 pandemic that hit the country badly followed by another event that escalated inflation in the country – the Russia-Ukraine war, which led to monetary tightening in the US, which makes the US debt market more attractive to foreign institutional investors (FIIs).

Hence, there has been a shift of funds from Indian markets as foreign investors have been exiting leading to a huge sell-off.

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