US Central Bank raises its interest rate by 0.75%, highest in the last 28 Years
Tags: Economy/Finance International Relations
The United States Central Bank, Federal Reserve has announced an increase of 0.75% hike in its benchmark interest rates in order to curb the spiraling inflation in the country. The increase of 0.75% rate was the highest increase since 1994.
Now the short term federal fund rate target is 1.55 to 1.75%. The short term Federal fund rate is like the policy repo rate in India.
- Like the policy repo rate of RBI, it is the rate at which the Federal Reserve lends to the banks for an overnight period (24 hours). But unlike policy repo rate in India which is fixed, in the United States the Federal Reserve always announces a range of federal fund rate with minimum and maximum range.
- With the increase in the Federal fund rate, the banks are expected to raise their interest rates leading to an increase in credit card, home loan etc interest rate in America.
- The chairman of the Federal Reserve Jerome Powel said that the Federal Reserve is likely to hike its interest rate again by 0.75% in its next July 2022 meeting.
- This policy move of the Federal Reserve’s comes after the inflation rate hit a high of 40 years in May 2022. The consumer price Index increased to 8.6% signaling more increase in prices in the future.
- Due to the continuing Russia-Ukraine war the prices of oil and food prices are increasing in the world and it is expected to remain high in the near future. The continued covid related lockdown in China has also disrupted global supply. China is a major supplier of industrial and consumer goods to America.
- The Federal Reserve has lowered its growth forecast for the U.S economy to 1.7% from the earlier 2.8% in 2022.
Effect of the rate hike for India
The effect of the Federal rate increase will have consequences for the world economy as the United States is the largest economy of the world and a major source of capital and investment.
It will adversely affect the capital flow
- The United States is a major source of capital in the world and India. Normally the American investor burrows at a cheaper rate in the U.S and invests in India where Interest rates are typically high.
- Now with the increase in rates in the U.S the profit margin of the US investor will reduce and they will prefer to invest in the US debt market. They will sell bonds in India and take back the money to the United States.
- To stop the outflow of money from India, the RBI will also have to increase the interest rate so that it is attractive for the American investor. But increase in Interest Rate will make loans costly in India adversely affect future growth in India.
Shortage of Capital
India is a poor country but a rapidly growing economy. It needs huge capital to grow at least 8% per annum, part of which come in the form of Foreign Investment .
With the expected flight of foreign capital from India due to rate hike, the Indian economy will face shortage of capital .
It will adversely affect future economic growth and employment generation.
Increase in the price of Gold
Typically when the Inflation increases people use to buy assets which are considered to be safe and inflation proof, like Gold. So people will buy more gold which will lead to its price increase.
India is one of the largest importers of gold in the world and the gold import bill is likely to increase in future.
Effect on Trade
The United States is the largest trading partner of India and a major buyer of Indian goods and services. If the growth rate of America declines then the chances of increasing Indian exports to the U.S will also decline.
Federal Reserve
It is the central bank of the United States.
It was set up on December 23, 1913.
Headquarters : Washington D.C
Chairman : Jerome Powell
Do you know that American Dollar is also called as Green back .
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