Moneycontrol Bureau

The US Federal Reserve is widely expected to raise the policy interest rate at the end of the two-day Federal Open Markets Committee meeting beginning tomorrow.

Global markets are betting on an increase of 25 basis points, a hike sizeable enough to redirect capital flows across asset classes. Most importantly, it will result in a temporary flow of capital into US government bonds as the returns will be higher.

Moneycontrol decodes what a likely increase in interest rates in the US means for India

Impact on economy:

Dollar outflows could weaken the rupee, and hold the RBI back from cutting interest rates as that could lead to further outflows. With crude prices on the rise, a weak rupee will inflate the import bill and put pressure on the government’s finances.

Already, demonetisation and the resultant currency shortage has dampened household spending. This in turn could hurt firms already sitting on vast unused capacities in consumption-linked sectors.

Impact on market:

An increase in US Fed rate will be negative for emerging markets in general, India included. That is because a rate hike will improve the yields on US government bonds. In other words, the bonds will offer a better rate of return than before.

This could prompt global money managers to shift a part of their money into US government bonds. More often than not, fund managers sell a part of their holdings in emerging market equities and deploy that money in US bonds.

Impact on companies:

For an exporter, a stronger dollar would mean higher earnings in rupee terms. But stiff competition and anemic demand in most export markets means that exporters won’t have much to cheer about.

Imported raw material such a copper, aluminum and machinery can turn expensive, potentially squeezing margins of companies dependent on them to make products. This may lead to hike in prices of goods such as cars and televisions.

The rupee’s slide can also hurt companies with foreign currency loans as repaying in dollars will get costlier.

Impact on startups:

An increase in US Fed rate will likely lead a shift of part of their capital and even their focus away from markets such as India towards the US. The limited liability partners such las large pension funds and insurance companies which used to invest in venture capital and private equity funds may do so now in funds focused at home, than in Asia. This may likely to lead to more consolidation, shutdowns, and lowering of valuations of Indian startups in the months to come.

Impact on your investments:

A stronger dollar could negatively impact gold prices. Hence, financial planners suggest staying away from the yellow metal for the time being. Equities could be volatile in the short term, but investors should stick with their investments in quality companies.