The US Federal Reserve on Wednesday raised interest rates in a widely expected decision and said it expects as many as three rate increases during 2017.
The Fed increased the federal funds rate to a range of between 0.50% and 0.75%. This is the first increase since December 2015 and comes just a month before Donald Trump takes over as US President on 20 January.
In its statement announcing its decision, the Fed said that the US labour market had strengthened since its last meeting in November and that economic activity had been expanding at a moderate pace since mid-year.
But what does the Fed’s decision and the spectre of future hikes mean for emerging economies such as India?
Drag on markets: Indian markets are likely to see some outflows and fall on Thursday, especially because more rate hikes could be in the offing. A strong US market will mean a flight of capital from countries such as India, as US investors will have an extra incentive to invest their money back home rather than in riskier regions.
Rupee could be under pressure: The rate hike is a clear signal that the US economy is strengthening. This may weaken the Indian rupee against the US dollar, at least in the near term. This, coupled with the fact that oil prices are on the rise again, will see India’s current account deficit widen, and inflation inch up.
This could negate any post-demonetisation gains on the inflation front. Retail inflation in India is at its lowest levels since August 2015 following the Narendra Modi government’s decision to ban Rs 500 and Rs 1,000 notes, which made up for 86% of the total cash in circulation in a country that deals almost entirely in cash.
Bond yields could rise: This could happen especially if there are any further rate increases next year.