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How likely US Federal Reserve rate hike could impact India (Relevant for GS Prelims, GS Mains Paper III; Economics)

Possibility of rate hike
The US Federal Reserve is expected to raise the key interest rate for the second time in 2018. The projected rate hike comes in the backdrop of a sharp uptick in hirings alongside a rising inflationary trend in the US economy, with the consumer inflation readings on both the headline and core (excluding energy and food components) expected to run well above the Fed’s target of 2 per cent. Analysts expect a quarter-point hike in interest rates with a possible projection of more increases this year.

How does RBI rate hike balance the situation?
A Fed rate hike could potentially impact the macroeconomic outlook in other emerging economies, including India. The RBI’s Monetary Policy Committee, which hiked the repo rate by 25 basis points in its meeting last week, effectively signalling a reversal of the easy money policies of the last three years, seems to have been partly prompted by the Fed’s rate action.

Following the RBI rate hike, foreign investors can retain their arbitrage advantage. Had the RBI kept the rate unchanged while the Fed hiked them further, there would have been greater capital outflows, leading to further weakening of the rupee. India’s debt and equity markets witnessed outflows of over Rs 40,000 crore in April and May.

What is the impact on equity markets?
Equity market performance has varied across regions, with the Advanced Economies (AEs) clocking modest gains on strong first quarter earnings and abating of trade tensions, while stocks in major Emerging Market Economies (EMEs) have faced selloffs on a rising dollar and expectations of further rate hikes by the Fed.

What is the impact on currency markets?
In the currency markets, the US dollar touched its highest level in May since December 2017. The euro slid significantly against the dollar reflecting a combination of factors, including tepid growth data for the Euro Area, and political uncertainty in its southern periphery, including Italy. EME currencies have, by and large, depreciated against the US dollar.

(Adapted from The Indian Express)

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