The currency of every nation carries an interest rate. The interest rate is the parameter to find the strength or weakness of an economy. The rise and fall of interest rate impact an economy to a great extent. The interest rate of the central bank of any nation is called the nation’s interest rate.
The Interest rate of the central bank of any nation does tend not to fluctuate very often. The interest rate is increased during the scenarios when inflation goes uncontrolled and money’s buying power decreases. To bring the imminent danger in control, the central bank increases the interest rate. The increased interest rate makes the borrowed money expensive which demotivates the consumers to buy new products or incurring additional debts. Hence, the situation comes under control after some time.
If the scenario changes and the economy slows down, the central banks decrease the interest rate. The low-interest rate encourages businesses within the nation to borrow more money and expand the business. A low-interest rate promotes the growth of the economy of a nation.
The fluctuation in interest rate does not only create an impact in the economy of the nation but it may have a global implication too. Especially if the interest rate fluctuates in leading economies such as the United States, the emerging economies like India become vulnerable to it. The interest rate fluctuation of the US Federal Reserve (FED) which is the central bank of the US can bring turbulence in the Indian economy.
The FED Rate Fluctuation and Indian Economy
Both the increase and decrease in the interest rate of FED influences the Indian economy. The interest rate fluctuation impacts foreign investment in India. The developing countries like India tend to have a higher interest rate than those developed European countries. The foreign investment institutes such as FIIs (foreign institutional investors) borrow money from the US at a low interest rate and invest it in countries like India where the interest rate is higher. If the interest further lowers, the investors will get encouraged to invest in economies like India as the scope of better returns can be found. More investment will increase the capital flow and the Indian economy will witness a raise.
In the scenarios of the increasing interest rate of FED, the interest rate difference of the US and India minimises and the investors withdraw the investment as India becomes a less attractive country for investment. Reports say that the recent hike of FED interest rate resulted in the selling of stocks worth ₹ 55,935 crore and debt securities worth ₹ 52,823 crores by FII in the year of 2018-19. As a result, some considerable amount of money has moved out of the Indian economy and flown back to the US. Such happenings are certain to decrease the value of Indian currency against the US dollar.
The mentioned above is the overall impact that the Indian economy has to face because of the fluctuation in the international interest rate. Now let’s learn how the different sectors of the Indian economy are likely to react to the interest rate hike.
Impact on Bonds
The increased international interest rate is likely to have a negative impact on investment of bonds. The hiked interest rate will improve the yields and in a bond investment of the respective country. The investment in bonds will offer a better return if the interest rate is high. So, if FED hikes interest rate, the global money managers are prompt to shift a part of their money to the US. The fund managers sell a part of their holdings in emerging economies like India and deploy the money in US bonds.
Impact on Companies
The interest rate high may seem to be a pain for companies too. The imported raw materials such as copper, aluminium and machinery becomes expensive during the increased interest rate. If the raw material becomes expensive, it may shrink the margins of the company. Companies will not tolerate the situation for long and eventually increase the price of the product. The situations like this will have the ultimate impact on the consumers as they have to buy the same product at a higher price. If any company has a loan in foreign currency, the cost of credit will increase along with the hiked interest rate.
But in the case of an export company, it will earn a higher profit as the dollar will be stronger than INR.
Impact on your Investments
The investments are also vulnerable to the fluctuation of international interest rate. The falling value of INR negatively impacts in the gold prices. So the gold which you may have purchased with high price losses it’s value. At the times of the stronger dollar value, the equities may become volatile for a short period of time. But the financial experts advise not to withdraw the investment during such market conditions as you may get nominal to no returns on your investment.
The Present Scenario
The present FED interest rate is 2.5% which is highest recorded since April 2008. The interest rate has been increased by the central bank of US consecutively for several times. The impact of the same has been noticed in 2018-19 that the FII sold stocks worth ₹ 55,935 crore and debt securities worth ₹ 52,823 crores. The withdrawal amount has to be converted to the dollar which results in pushing up the demand of dollar.