What will be the impact of US Fed's interest rate hike on India?

Last week, the Federal Reserve not only hiked its benchmark interest rate by 25 basis points, but also hinted for the ensuing series of such hikes in the current calendar year.

Of course, this rate hike was first since 2018. It is going to pave the way for the RBI to break jinx and start increasing its key policy rats from the next policy review onwards.

Fed's move was largely priced in given the elevated US inflation prints in January and February and the expected spillover impact on global energy and commodity prices from the sanctions on Russia. High oil and commodity prices do induce some short-term vulnerability and complicate the case for the RBI's monetary policy conduct. However, despite sustained selling by foreign investors in the equity markets and wider monthly trade deficits, the Indian bond, currency, and equity markets have remained reasonably well-behaved.

India is not as 'fragile' as it used to be until a decade ago. What with corporate, household, and bank balance sheets are much better than before. More importantly, the RBI with its +$600 billion hordes of foreign exchange reserves is in a good position to manage volatility in the currency markets.

Yes, normalisation of key policy rates is in the offing. Still, it comes with a rider. As analysts point out, that the best way to do normalisation is by allocating to short-term funds liquid funds to benefit from the rise in interest rates. The ongoing market correction is leading to valuations getting palatable and they are adding on to their cyclically tilted value portfolio.

There may be short-term hiccups given the uncertainty on the geopolitical front. There will also be volatility in market expectations due to the tight spot that Central banks find themselves. Whatever be the case, India is on the cusp of a sustained revival, which will drive economic growth and corporate earnings in the medium term.

The long and short of the story is, the real scare would be in the middle of this year when the Fed announces its plan for the Quantitative Tightening (QT). One has to see, as a part of QT, if the Fed sells treasury bonds to reduce its balance sheet, as it will lead to higher US bond yields and can cause volatility in emerging markets.

Again, inflation is the bigger worry, we might see certain periods of extreme negative sentiments towards emerging market assets in a risk-off phase. Investors should be cognizant and prepared for that given that the cycle is forecasted to see +200 bps in rate increases by the Fed.

True, higher rates can slow down inflation but they can also increase cost of borrowing and slow down the economy. This is the message, the RBI need to keep in mind while increasing key policy rates, which is going to be a certainty now, in future.