Here's why a change in the US interest rates matters to India

Rupee and dollar

The US Federal Reserve has held interest rates steady in the range of 2.0 to 2.25 percent on November 8, citing a healthy economy that was marred only by a dip in the growth of business investment.

The Fed has hiked rates three times this year and is widely expected to do so again in December.  Moneycontrol decodes what happens to India when the US decides to change their interest rates.

After the 2008 Lehman Brothers crisis, the US adopted an easy money policy to incentivise borrowing and help the country's economy grow, even lowering interest rates to zero percent at one point.

When the interest rates were lowered in the US, it prompted global investors to look for lucrative options beyond their shores. According to reports, Foreign institutional investors (FIIs) invested huge sums in India. FIIs bought Indian stocks worth Rs 6,62,000 crore and invested Rs 3,93,000 crore in buying Indian debt. This led to a stock market rally, which in turn led to the Reserve Bank of India (RBI) to lower interest rates.

On the other hand, when the US hikes key interest rates, it spells bad news for the Indian economy. This is because a rate hike will improve yields on US government bonds, offering a better rate of return.

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. This prompts an outflow of US dollars from the Indian economy that weakens the rupee.

A rate hike from the US would cause the RBI to follow suit, and prevent a cutting of its interest rates. This leads to further dollar outflows. India continues to face this risk over the next few years as seen from recent trends.

The rupee has touched a record low of 73.41 to the dollar, on the back of strong demand for the greenback from importers amid rising global oil prices.

Taking a call that the US economy does not need as much help since the end of the financial crisis, the Fed has increased its interest rates eight times since 2015.

(With inputs from Reuters)