Here’s why the US is raising interest rates and how it’s affecting Indian markets

  • Over the past few months, Indian stock markets have fallen on fears of a possible rise interest rate in the USA. What is the link ?
  • Not only India, but many global markets also saw weakness, expecting the US administration to raise interest rates.
  • Foreign investors withdrew funds from the country, driving the market down, but why? Let’s understand the real reason.

Over the past six months, India’s benchmark Sensex has slid over 7%, witnessing huge swings and one of the reasons you may have heard is fears that the US Fed will increase its interest rates after months of quantitative easing.

Not only Indian stock exchanges, but stock markets around the world have seen weakness over the past couple of months due to this fear.

Why do markets fear US interest rate hikes?

One thing that impacts almost every other country in the world is high inflation.

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

It all started with the COVID-19 pandemic which shook the world, with countries around the world halting operations to curb the spread of the infection. Millions of employees have been laid off as businesses could not survive due to the lack of movement of goods, leading to disruption of supply chains.

At the same time, consumer demand remained very high and, as supply struggled, commodity prices rose. While inflation was already high in many countries, another event hit the world this year: Russia’s invasion of Ukraine.

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

Today, consumers around the world are paying higher prices for basic necessities like food, oil and gas, as Russia’s war on Ukraine has disrupted supply chains, oil and food exports facing crisis due to Western sanctions.

How to control the rise in inflation?

Many major economies around the world are struggling with rising inflation – the list includes the United States, Japan, Australia and major European countries like Germany, France and Italy, among others.

Due to high inflation, the US central bank has sought to halt economic stimulus measures – also known as quantitative easing – which began after the pandemic.

One way to do this is to raise interest rates.

Why is the United States raising interest rates?

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

Simply put, higher lending costs will have a direct impact on purchasing power, meaning fewer people would be able to buy homes, cars, and even businesses would struggle to grow. All of this will eventually dampen demand and, subsequently, inflation.

Why the Indian stock Exchange suffer from rising interest rates in the United States?

Rising US interest rates do not bode well for Indian markets as it may cause foreign investors to withdraw their money from emerging markets like India to the safe and secure markets of the United States.

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

At a time of rising interest rates in the US market, foreign institutional investors (IFIs) find it safer and more attractive to invest in the US debt market rather than going elsewhere (such as in emerging markets at risk like India).

In the meantime, the Indian currency continues to depreciate on concerns over crude oil and global inflation. It now stands at ₹76 per dollar, up from ₹74 last year. A falling rupee affects foreign investors as it decreases their income. For example, 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 depreciation of the rupee to ₹76, the value of the investor’s investment has fallen to $1,315.

This is all due to the COVID-19 pandemic which hit the country hard, followed by another event which drove up inflation in the country – the Russian-Ukrainian war, which led to monetary tightening in the states States, making the US debt market more attractive to foreign institutional investors (IFIs).

Consequently, there was a transfer of funds from the Indian markets as foreign investors pulled out, resulting in a huge sell-off.

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