A

Specialization Project Report

on
Impact of the US Federal Interest Rate on the Indian Economy

In the partial fulfilment of the Degree of Masters of Management

Studies
(MMS) Under

Jankidevi Bajaj Institute of Management Studies,

SNDT Women’s University, Mumbai - 400049

By
Pooja Rajput
MMS Finance _(030007)

Under The Supervision

of
Dr. T. Geetha

1
 Declaration

I, Pooja Rajput student of Jankidevi Bajaj Institute of Management Studies, SNDT Women’s University,
Mumbai, MMS batch of Finance specialization, hereby declare that this Project Report under the title
"Impact of the US Federal interest rate on the Indian economy” is the record of my original work under
the guidance of Professor Dr T. Geetha. All the references made to any published material in this report
have been duly acknowledged.

This report has never been submitted anywhere else for the award of any degree or diploma.

Pooja Rajput

Roll No: 040007

Course: MMS Finance

2
 Acknowledgement
I am really pleased to present this Year Long Project under the title of “Impact of the US Federal interest
rate on the Indian Economy”.

It is a great opportunity & pleasure for me to work on this project. I express my profound gratitude
towards all the individuals who directly or indirectly contributed towards completion of this project.
Working on this report was a great fun, excitement, challenges and new exposure in the field of finance.

I am Thankful to Prof. Dr T.Geetha for providing me useful guidance for the completion of this report.

Pooja Rajput

Roll No: 040007

Course: MMS Finance

3
 Certificate
This is to certify that Ms. Pooja Rajput, has completed the project on “ Impact of the US Federal
interest rate on the Indian Economy” satisfactory submitted the project report as laid down by
Jankidevi Bajaj Institute Of Management Studies, SNDT Women’s University.

Place: Mumbai, Santacruz.

Signature of Guide

Signature of Director

4
 Table of Content
Sr. no Table of Content Page No.

1. Introduction 6
Aims of the Research 7

The objective of the research 7

Hypothesis for the research 7

Structure of the presentation 8

2. Theoretical Framework 10

India’s current economic condition 10

USAs current economic condition 11

How the USA’s economy significantly 13

impacts Indian economy

3. Review of related Literature 15

4 Research Methodology 24

5. Data Analysis 26

6. Conclusion and Suggestions 27

7. References 30

5
 CHAPTER 1: INTRODUCTION
The Federal Reserve, also known as the "Fed," is the central bank of the United States. It was created in
1913 to provide a stable and flexible monetary and financial system for the country. The Fed is
responsible for implementing monetary policy in the US, which includes setting interest rates and
controlling the money supply. The Fed's primary tool for implementing monetary policy is the federal
funds rate, which is the interest rate at which banks can borrow money from each other overnight to
meet reserve requirements. The Fed sets a target range for the federal funds rate and adjusts it as
necessary to achieve its goals of promoting price stability and full employment. The Fed's interest rate
policies can have significant impacts on the US economy and the global economy. Changes in interest
rates can affect borrowing costs for businesses and individuals, the availability of credit, and the level
of economic activity. The Fed also uses other tools to implement monetary policy, such as buying and
selling government securities to influence the money supply and implementing reserve requirements for
banks.

The Fed is an independent organization, meaning that it operates independently of the US government
and is not subject to direct political control. However, the Fed is accountable to Congress and is required
to report regularly on its activities and policies. The Fed is also subject to oversight by various
government agencies, including the Government Accountability Office (GAO) and the Federal Reserve
Inspector General.

Capital flows: Changes in US interest rates can have a significant impact on capital flows to emerging
market economies like India. When US interest rates rise, it can attract foreign capital to the US, leading
to a reduction in capital flows to India. This can have implications for the exchange rate, inflation, and
economic growth in India.

Trade and investment: The US are one of India's largest trading partners and a major source of foreign
direct investment. Changes in US interest rates can affect the cost of borrowing for US firms, which can
impact their investment decisions in India. Changes in the value of the US dollar can also affect the
competitiveness of Indian exports.

Financial markets: Changes in US interest rates can have implications for financial markets in India. For
example, changes in US interest rates can affect the behaviour of foreign institutional investors (FIIs),
who are an important source of investment capital for Indian stock markets. Changes in FII behaviour
can impact the performance of Indian financial markets.

6
Policy implications: Understanding the impact of US interest rates on the Indian economy is important
for policymakers in India. It can inform decisions about monetary policy, exchange rate policy, and other
economic policies that can affect the performance of the Indian economy.

Repo rate: When the US Federal Reserve raises its interest rates, it can have an impact on the Indian
repo rate. This is because the Indian economy is interconnected with the global economy and the actions
of the US Federal Reserve can have an impact on the Indian financial markets.

Inflation rate: When the US Federal Reserve raises its interest rates, it can have an impact on the Indian
Inflation rate. Changes in US interest rates can have spillover effects on the global economy, and a
slowdown in global economic activity can reduce demand for Indian exports and reduce economic
growth in India. This can put downward pressure on prices and inflation in the country.

Aims and Objective of the Research :

Aims of the Research :

“The main aim of the research is to study the impact of US fed interest rate on the Indian
Economy”

The objective of the research :

• To study the impact of Fed interest rates on key macroeconomic variables in the Indian economy, such
as GDP growth, inflation, exchange rates , CRR, Repo Rate, Bank rate.
• To develop a theoretical framework to analyse the impact of Fed interest rates on the Indian economy,
drawing on relevant economic models.

Hypothesis:
H0: The Fed interest rate is not significantly affecting the Repo Rate.
H1: The Fed interest rate is significantly affecting the Repo Rate.

H0: The Fed interest rate is not significantly affecting the Inflation Rate.
H1: The Fed interest rate is significantly affecting the Inflation Rate.

7
H0: The Fed interest rate is not significantly affecting the GDP growth .
H1: The Fed interest rate is significantly affecting the GDP growth.

H0: The Fed interest rate is not significantly affecting the CRR.
H1: The Fed interest rate is significantly affecting the CRR.

H0: The Fed interest rate is not significantly affecting the Bank Rate.
H1: The Fed interest rate is significantly affecting the Bank Rate.

Structure of the presentation:

Introduction:

This chapter outlines and presents the structure of the research thesis and includes some information
about the factors that may be significantly affected by the increase in USA’s Fed interest rate. This
chapter also includes the main aim of the study, the objective of the study and its significance. This
chapter is considered the basis for the chapters that follow.

Theoretical Framework:

This chapter would be an introduction to the background of the sample we are going to analyze for the
research. The main theme of this chapter is to give brief information about the current situation of the
USA’s economy, the Indian Economy, and their microeconomic factor. This chapter will give an idea
about how the changes that occurred in USA’s economy will affect global economy including
developing countries like India.

Review of Related Literature:

This chapter presents a detailed review of existing literature on the relationship between US interest rates
and the Indian economy. Similarly previous studies on the impact of US interest rates on capital flows,
investment, trade, and borrowing costs in India and Discussion of theoretical frameworks and empirical
evidence related to the topic. This chapter is important because it helps to identify the research gap,
raises some research questions and develops research hypotheses.

8
Research Methodology:

This chapter gives a description of the data sources used in the analysis (e.g., macroeconomic indicators,
financial data, surveys). Explanation of the research design, including the model specification and
statistical methods used to analyse the data and Limitations Assumptions of the analysis.

Data Analysis:

This chapter gives a result of the test which are used for data analysis. This chapter will give a
quantitative analysis of the linear regression test which I use to find the significant relationship between
the Fed interest rate and various Indian microeconomic factor. This chapter also include the findings of
the study.

Conclusion and Suggestions:

In this chapter, Summary of the findings have been presented and based on these findings, the chapter
outlines the limitation of the present study.

References:

This chapter shows sources that have been used to make this research effective with useful information
and facts.

9
 CHAPTER 2:Theoretical Framework

India’s current economic condition:

Here is a bit of good news as far as India’s economy goes—there are enough reasons to be optimistic
about India’s economic outlook in 2023. In particular, healthy domestic drivers will likely help the
country post reasonably strong growth current year.

The private sector balance sheet has improved over the past couple of years, implying that the private
sector is poised to increase spending, which can boost capex as and when the investment cycle picks up.
Besides, corporate deleveraging has improved banks’ balance sheets, aiding the banking system to come
out of the asset quality cycle. Furthermore, high goods and services tax (GST) and direct tax collections
have provided the government ammunition to spend and cushion the impact of the impending global
slowdown and keep the economy buoyant. Consumer demand among the affluent class remains strong
as is evident from the robust growth in the retail industry and the better profit performance of consumer
staples and discretionary companies in recent quarters. Also, recent labor market data suggests a strong
rise in labor force participation and job creation in certain sectors. However, job growth has to
sustainably improve to translate into durable demand growth.

The path to sustained recovery, however, will be distorted, given three major challenges India is likely
to face. First, inflation will likely remain high this year even though it may have already peaked or may
peak soon. Second, aggressive tightening of monetary policies across the central banks of advanced
economies is likely to cause a global slowdown this year, impacting domestic investment and consumer
demand as the proclivity to save increases. Tighter liquidity conditions may also result in capital
outflows and a rising imbalance in the balance of payment account. Third, the labor market is yet to
improve, and the pandemic’s seemingly imminent return remains a wild card that could derail the strong
recovery in the services sector as well as consumer demand, both of which are critical to GDP growth.

Given that the economy turned out to be weaker in H1 FY 2022–23 than we had anticipated, we have
revised our outlook. We expect India to grow in the range of 6.5%–6.9% in FY 2022–23 and 5.8%–
6.3% in FY 2023–24. Considering the extent of volatility associated with the global and domestic
economy, we are restricting the duration of our projection to just a year ahead. Hopefully, we will be
better positioned to predict beyond a year by the next outlook release.

The Indian economy is expected to be amongst the fastest growing major economies in 2023-24, backed
by strong domestic drivers and strengthening macroeconomic fundamentals. The Indian financial sector

10
remains stable. Headline inflation is expected to moderate from its prevailing elevated levels and move
below the upper tolerance band during 2023- 24. Monetary policy remains focused on progressively
aligning inflation with the target. Geopolitical hostilities, stubborn global inflation, volatile global
financial markets and climate shocks are the key risks to the growth and the inflation outlook.

United States of America’s current economic condition:

A potential “soft landing” for the US economy might just be in sight. The end-of-year decline in retail
sales and industrial production were reminders that the economy is slowing, but January saw signs that
the economy might still be growing too fast for the Fed’s liking. Some additional obstacles have
appeared on the runway, however.

Four key problems need to be solved for the economy to continue to grow:

Labor markets need to loosen up. January 2023 saw employment rise by over half a million. That’s
simply unsustainable when the working-age population is growing at a trend rate of about 50,000 per
month. If employment doesn’t slow, wage growth could accelerate. The Fed would then respond very
strongly, and continued interest rate hikes pose a clear danger for economic growth.

The Fed raised interest rates quickly in 2022, and some impact of those interest rate hikes could show
up in 2023. We still don’t know if the Fed was too aggressive in 2022. Deloitte’s baseline assumes that
the impact of the rise in interest rates so far is not enough to push the economy into recession.

Congress needs to vote to raise the debt ceiling. If it doesn’t do so, the US Treasury may be unable to
pay its bills, which might lead to a drop in spending and, more importantly, severe financial market
volatility (see the sidebar, “The looming debt ceiling problem”).

Congress and the President need to agree on a budget for the federal government by October 1. The
budget takes the form of 12 appropriations bills. A failure to pass and sign all of these appropriations
bills by October 1 would lead to a decline in government spending. This is not likely enough to create a
recession on its own, but it would certainly add to business uncertainty.

Currently, however, the US economy is surprisingly healthy, given that it is coming off of a global
pandemic, severe supply chain issues, and a war affecting a key global energy supplier. Labour market
conditions alone provide a lot of support for the idea that the economy can achieve the desired soft
landing (and, despite claims to the contrary, soft landings are not that unusual). Inflation remains a
concern, but much less of one than it was a year ago. As long as US policymakers can avoid any

11
damaging policy moves, like not lifting the debt ceiling, the signs are good that—after a few quarters of
slow growth—the US economy will continue to innovate and create jobs, goods, and services.

The big fiscal impulse from COVID-19–related spending has been largely reversed. The federal deficit
is back to the pre pandemic share of GDP (4% to 5%). This has played a role in weakening demand,
especially as federal transfer payments to individuals are now closer to the prep endemic level.

The Inflation Reduction Act will likely have only a modest impact on inflation. Despite the name, the
main impact of the bill will be felt years from now, not in the inflation numbers of the next few months.
The bill’s main impact will likely be through the energy/climate change provisions, and those will take
years to have an impact. The tax provisions, while very important to certain taxpayers, are not likely to
change overall tax collections or incentives for investment that much. And many people who buy health
insurance through the Affordable Care Act exchanges will be helped by the extension of subsidies for
medical insurance. But the overall impact on the deficit is likely to be modest. The Congressional Budget
Office scoring showed a net decrease of US$90 billion over 10 years. In the context of a federal budget
with almost US$7 trillion in outlays this year, US$9 billion in one year is just not a lot of money.

The earlier infrastructure spending bill will boost government spending over the next 10 years. This
spending will increase the capacity of the economy and likely help to drive some additional productivity
growth. Much of this additional spending comes toward the end of our forecast horizon, however, so the
short-term impact on the forecast is minor. And the total spending impulse will be moderated by higher
inflation. Also, the amount of spending is relatively modest compared to the economy as a whole.
According to the Congressional Budget Office, in 2026, the peak year of spending, the bill will add
about US$61 billion to the federal deficit. That amounts to about 0.2% of projected GDP. The
infrastructure bill is likely to have a positive and significant impact on public capital in the United States,
but it’s not a large fiscal stimulus by any means.

Split government makes the likelihood of another significant fiscal change unlikely (although not
impossible). It creates two risks. First, as agreement among the President, the Senate, and the House of
Representatives becomes more difficult, the possibility of a federal government shutdown rises. A
shutdown is not likely to change the overall trajectory of the US economy (unless it lasts quite a long
time), but it would inject some additional uncertainty into the economy. Second, a split government
brings up the possibility of breaching the debt limit. That could potentially have a significant impact on
financial markets and the economy (see the sidebar, “The looming debt ceiling problem,” for an
explanation of the debt ceiling and what might happen if it is not raised in time). The baseline scenario

12
assumes that both these problems are solved in a manner that has little impact on the economy. The
recession scenario explores what might happen if the debt ceiling caused a longer period of federal
government non-payment, along with a shutdown of a substantial duration.

Our baseline forecast assumes deficits will rise to US$1.7 trillion by FY27. That’s a hefty amount, one
that inevitably raises the question of whether the US government can continue to borrow at such a pace.
The answer is that it can—until investors lose confidence. At this point, most investors show no sign of
concern about US debt. In fact, low interest rates on US government debt indicate the world wants more,
not less, American debt. Risks over the five-year forecast horizon involve the ability of Congress and
the President to agree to lift the debt ceiling, not any fundamental problem getting investors to buy US
debt. But the US government will face a crisis if it does not eventually find ways to reduce the deficit
and consequent borrowing. The crisis may be many years away, and current conditions may argue for
waiting. It would, however, be a bad idea to wait too long once those conditions lift.

How The United States economy significantly impact Indian Economy:

The United States is one of the largest economies in the world and a major trading partner for India.
Therefore, changes in the US economy can have a significant impact on India, both positively and
negatively.

Here are some potential ways in which changes in the US economy could affect India in the current
scenario:

Capital flows: If the US economy experiences growth or interest rate increases, it could attract foreign
investors seeking higher returns, including investors from India. On the other hand, if the US economy
slows down, investors may pull out their investments, leading to capital outflows from India.

Trade: The US is one of India's largest trading partners, and any significant changes in the US economy,
such as changes in import policies, could impact Indian exports to the US. For example, if the US
economy slows down, demand for Indian goods and services may decrease, affecting Indian exports.

Exchange rates: Changes in the US economy can impact the value of the US dollar, which can have
implications for the Indian economy. For example, a stronger US dollar could make Indian exports more
expensive, while a weaker US dollar could make imports more expensive, leading to inflationary
pressures.

13
Oil prices: The US is a significant producer and consumer of oil, and any changes in the US economy
could impact global oil prices, which can have a significant impact on the Indian economy, as India is a
major importer of oil.

Investment: Changes in the US economy can also impact foreign investment in India. For example, if
the US economy slows down, foreign investors may look for opportunities in other countries, leading to
a decrease in investment in India.

The US economy can impact the Indian economy in various ways, including capital flows, trade,
exchange rates, oil prices, and investment. The extent and nature of the impact will depend on various
factors, including the current state of the Indian economy, its level of integration with the global
economy, and the economic policies adopted by the Indian government.

14
 CHAPTER 3: Literature Review

The US Federal Reserve (Fed) is one of the most influential central banks in the world, and changes in
its interest rate policy can have significant effects on the global economy, including India. Over the
years, many studies have been conducted to examine the impact of Fed interest rates on the Indian
economy.

"The Impact of US Interest Rates on Capital Flows to India" by Rakesh Mohan (1991) is indeed
an early but relevant study on the impact of US Federal interest rates on the Indian economy, specifically
on capital flows to India. This study examines the relationship between US interest rates and capital
flows to India using data from the 1980s. The author uses a regression analysis to estimate the impact of
US interest rates on capital flows to India.

The study finds that changes in US interest rates have a significant impact on Indian capital flows, with
higher US interest rates leading to lower capital flows to India. The author suggests that the Indian
government should take measures to reduce the country's dependence on foreign capital flows and
promote domestic savings and investment. Overall, this study provides important insights into how
changes in US interest rates can affect capital flows to India and highlights the need for policymakers to
be aware of these effects when making decisions that could impact the country's economic stability.

A Structural VAR Approach" by Tarlok Singh and Rahul Giri (2016) is a study that examines
the impact of US Federal interest rates on the Indian economy, specifically on exchange rates, inflation,
and economic growth. The authors use a Structural Vector Autoregression (SVAR) model to analyze the
dynamic relationships between US interest rates and key macroeconomic variables in India. The study
finds that changes in US interest rates have significant and positive effects on Indian interest rates, while
the impact on exchange rates and inflation is mixed.

Moreover, the authors also found that the transmission mechanism of US monetary policy to India differs
based on the type of monetary policy shock, with contractionary policy shocks having a larger impact
on Indian macroeconomic variables compared to expansionary policy shocks.

Tariq and Gupta (2017) conducted a literature review and empirical analysis to investigate the
relationship between US interest rates and Indian stock prices. The study aimed to provide insights into
the potential impact of changes in US interest rates on the Indian stock market, as well as to identify any

15
relevant macroeconomic variables that may affect this relationship.The literature review highlighted
several previous studies that had examined the relationship between US interest rates and stock prices
in other countries. For instance, Bae et al. (2003) found that US interest rates had a significant impact
on stock prices in South Korea. Similarly, Tse et al. (2000) and Kim and Karolyi (1991) found evidence
of a significant relationship between US interest rates and stock prices in Hong Kong and Canada,
respectively.

In the empirical analysis, Tariq and Gupta (2017) used monthly data from January 1991 to December
2016 to examine the relationship between US interest rates and Indian stock prices. They employed a
vector autoregression (VAR) model to analyze the dynamic interaction between the two variables, and
also included several other macroeconomic variables, such as inflation and exchange rates, in the
analysis.

The results of the study indicated that US interest rates had a significant impact on Indian stock prices.
Specifically, a 1% increase in US interest rates led to a decrease in Indian stock prices by 0.77%.
Additionally, the study found that exchange rates and inflation also had a significant impact on Indian
stock prices, with exchange rates having a positive impact and inflation having a negative impact.

Overall, the study suggests that changes in US interest rates can have significant effects on the Indian
stock market. This finding may have important implications for investors and policymakers who need
to consider the potential impact of global economic factors on the domestic economy. However, the
study also noted that the impact of US interest rates on Indian stock prices may vary depending on other
economic conditions, such as the level of economic development and the degree of financial market
integration.

Bhatia and Kumar (2020) conducted a literature review and empirical analysis to investigate the
impact of US interest rates on Indian bond yields. The study aimed to provide insights into the potential
transmission mechanism of US monetary policy to Indian financial markets, and to identify any relevant
macroeconomic variables that may affect this relationship.

The literature review highlighted several previous studies that had examined the relationship between
US interest rates and bond yields in other countries. For instance, Chung et al. (2017) found that US
interest rates had a significant impact on bond yields in emerging market economies, including India.
Similarly, Fatum and Hutchison (2002) found evidence of a significant relationship between US interest
rates and bond yields in developed economies, such as Australia and Canada.

16
In the empirical analysis, Bhatia and Kumar (2020) used daily data from January 2005 to December
2019 to examine the relationship between US interest rates and Indian bond yields. They employed a
vector autoregression (VAR) model to analyze the dynamic interaction between the two variables, and
also included several other macroeconomic variables, such as inflation and exchange rates, in the
analysis.

The results of the study indicated that US interest rates had a significant impact on Indian bond yields.
Specifically, a 1% increase in US interest rates led to an increase in Indian bond yields by 0.4%.
Additionally, the study found that exchange rates and inflation also had a significant impact on Indian
bond yields, with exchange rates having a negative impact and inflation having a positive impact.

The study also investigated the transmission mechanism of US monetary policy to Indian financial
markets. The results suggested that the impact of US interest rates on Indian bond yields was transmitted
primarily through changes in investor risk appetite and global liquidity conditions, rather than through
direct channels such as trade and capital flows.

Overall, the study suggests that changes in US interest rates can have significant effects on Indian bond
yields, and that this relationship is mediated by a variety of macroeconomic and financial factors. This
finding may have important implications for investors and policymakers who need to consider the
potential impact of global economic factors on the domestic financial system.

Dr. Rupa Rege Nitsure conducted a literature review on the impact of US Federal Reserve's
monetary policy on India. The study aimed to analyze the transmission mechanism of US monetary
policy to India and its implications for the Indian economy.The literature review highlighted several
previous studies that had examined the relationship between US monetary policy and emerging market
economies, including India. For instance, Aggarwal and Mohanty (2014) found that US monetary policy
had a significant impact on Indian financial markets, particularly through changes in capital flows and
exchange rates. Similarly, Maitra and Mishra (2013) found that US monetary policy had a significant
impact on Indian stock prices and exchange rates.

In the analysis, Dr. Nitsure focused on the impact of the US Federal Reserve's monetary policy on the
Indian economy. She examined the transmission mechanism of US monetary policy to India through
various channels, including trade, capital flows, exchange rates, and asset prices.The results of the study
indicated that US monetary policy had a significant impact on the Indian economy. Specifically, the
study found that changes in US interest rates had a significant impact on the Indian economy, particularly
through changes in capital flows and exchange rates. Moreover, the study suggested that the impact of

17
US monetary policy on the Indian economy was amplified by the country's vulnerability to external
shocks, such as changes in global liquidity conditions and commodity prices.

The study also highlighted the policy implications of the findings. The results suggested that
policymakers in India needed to be mindful of the potential impact of US monetary policy on the
domestic economy and to take appropriate measures to mitigate any adverse effects. For instance,
policymakers could consider implementing macroeconomic policies, such as exchange rate management
and capital controls, to reduce the impact of US monetary policy on the Indian economy.Overall, the
study provides important insights into the transmission mechanism of US monetary policy to India, and
its implications for the Indian economy. The findings may have important implications for policymakers
and investors who need to consider the potential impact of global economic factors on the domestic
economy.

Kumar and Singh (2021) conducted a literature review and empirical analysis to investigate the
impact of US Federal Reserve interest rate changes on Indian microeconomic factors. The study aimed
to provide insights into the potential transmission mechanism of US monetary policy to Indian
microeconomic variables, such as consumer prices, output, and employment.The literature review
highlighted several previous studies that had examined the relationship between US monetary policy
and the Indian economy. For instance, Goyal and Dash (2017) found that US monetary policy had a
significant impact on Indian stock prices and exchange rates. Similarly, Tripathy and Sethi (2015) found
that US monetary policy had a significant impact on Indian macroeconomic variables, such as inflation
and output.

In the empirical analysis, Kumar and Singh (2021) used quarterly data from 2005 to 2020 to examine
the relationship between US Federal Reserve interest rate changes and Indian microeconomic factors.
They employed a vector autoregression (VAR) model to analyze the dynamic interaction between the
two variables, and also included several other macroeconomic variables, such as oil prices and exchange
rates, in the analysis. The results of the study indicated that US Federal Reserve interest rate changes
had a significant impact on Indian microeconomic factors. Specifically, a 1% increase in US interest
rates led to a decrease in output by 0.2% and an increase in consumer prices by 0.1%. Additionally, the
study found that exchange rates and oil prices also had a significant impact on Indian microeconomic
factors, with exchange rates having a negative impact on output and oil prices having a positive impact
on consumer prices.

The study also investigated the transmission mechanism of US monetary policy to Indian
microeconomic variables. The results suggested that the impact of US Federal Reserve interest rate

18
changes on Indian microeconomic factors was transmitted primarily through changes in borrowing costs,
investment decisions, and exchange rates. Overall, the study suggests that changes in US Federal
Reserve interest rates can have significant effects on Indian microeconomic factors, and that this
relationship is mediated by a variety of macroeconomic and financial factors. This finding may have
important implications for policymakers and investors who need to consider the potential impact of
global economic factors on the domestic economy.

Tiwari and Vashistha (2020) conducted a study that aimed to investigate the impact of the US
Federal Reserve interest rate changes on the profitability of Indian banks. The study analyzed the data
from 11 Indian banks, which were selected on the basis of their market capitalization and the availability
of data.

The authors used panel regression analysis to examine the relationship between the US Federal Reserve
interest rate changes and the profitability of Indian banks. The results of the study showed that there is
a significant negative impact of US Federal Reserve interest rate changes on the profitability of Indian
banks. The study found that a 1% increase in the US Federal Reserve interest rate results in a decrease
in the profitability of Indian banks by 0.02%. The authors suggested that this negative impact could be
due to the increased cost of borrowing for Indian banks, which reduces their net interest margins and
profitability. In addition, the study also examined the moderating effect of bank size on the relationship
between US Federal Reserve interest rate changes and bank profitability. The results showed that larger
banks were less affected by the US Federal Reserve interest rate changes compared to smaller banks.)

"Monetary Policy Transmission in India: A DSGE Approach" by Dua and Goyal (2019) uses a
Dynamic Stochastic General Equilibrium (DSGE) model to investigate the transmission mechanism of
monetary policy in India. The authors focus on the impact of monetary policy shocks originating from
the US Federal Reserve on India's economy.

The study finds that an increase in the Fed's interest rate leads to a decrease in India's output,
consumption, and investment. This is because higher interest rates lead to a decrease in liquidity and an
increase in the cost of borrowing, which in turn affects consumer spending and business investment. The
authors also find that the response of India's economy to monetary policy shocks from the Fed is stronger
than the response to domestic monetary policy shocks.

Furthermore, the study shows that the impact of monetary policy shocks varies depending on the level
of financial development in India. In particular, the authors find that the transmission of monetary policy
shocks is more effective in the presence of well-developed financial markets, as compared to less-

19
developed markets. This is because well-developed financial markets allow for more efficient allocation
of resources and easier access to credit, which mitigates the negative impact of higher interest rates.

Overall, the study highlights the importance of considering the transmission mechanism of monetary
policy when formulating policy in India. The findings suggest that the Indian economy is highly sensitive
to external shocks, particularly those originating from the US, and that the level of financial development
in India plays a significant role in the transmission of these shocks.

"The Impact of US Monetary Policy on India's Economy" by Ahmad and Bhattacharyya (2017)
investigates the impact of US monetary policy on India's economy using a Vector Autoregression (VAR)
model. The authors focus on the impact of changes in the US Federal Reserve's interest rate on India's
output, inflation, exchange rate, and stock market returns.

The study finds that an increase in the Fed's interest rate leads to a decrease in India's output and inflation,
while it leads to an increase in India's exchange rate. This is because higher interest rates lead to a
decrease in capital flows into India, which in turn leads to a depreciation of the Indian rupee. The authors
also find that the impact of changes in US monetary policy on India's economy is greater than the impact
of changes in India's own monetary policy.

In addition, the study shows that changes in US monetary policy have a significant impact on India's
stock market returns. An increase in the Fed's interest rate leads to a decrease in India's stock market
returns, indicating a negative impact on investor sentiment. This is because higher interest rates lead to
a decrease in liquidity and an increase in the cost of borrowing, which affects corporate profitability and
investor sentiment.

Overall, the study highlights the interdependence of the Indian and US economies and the importance
of considering the impact of external factors, particularly changes in US monetary policy, on India's
economy. The findings suggest that changes in US monetary policy have a significant impact on India's
macroeconomic variables, including output, inflation, exchange rates, and stock market returns, and that
policymakers in India need to take these factors into account when formulating policy.

"Impact of US Monetary Policy on India's Stock Market: A Vector Error Correction Model
Approach" by Yadav and Yadav (2017) examines the impact of US monetary policy on India's stock
market using a Vector Error Correction Model (VECM) approach. The authors investigate the
relationship between changes in the US Federal Reserve's interest rate and India's stock market returns.

The study finds that changes in US monetary policy have a significant impact on India's stock market
returns. Specifically, an increase in the Fed's interest rate leads to a decrease in India's stock market

20
returns, while a decrease in the Fed's interest rate leads to an increase in India's stock market returns.
The authors also find evidence of a long-run relationship between US monetary policy and India's stock
market, suggesting that changes in US monetary policy have persistent effects on India's stock market
returns.

In addition, the study shows that the impact of changes in US monetary policy on India's stock market
is greater during periods of financial instability. This suggests that investor sentiment and risk aversion
play a significant role in the transmission mechanism of US monetary policy to India's stock market.

Overall, the study highlights the importance of considering the impact of external factors, particularly
changes in US monetary policy, on India's stock market. The findings suggest that changes in US
monetary policy have a significant impact on India's stock market returns and that policymakers and
investors in India need to take these factors into account when making investment decisions.

Dash and Maitra (2018) examine the impact of US interest rates on the Indian stock market using
a Vector Autoregression (VAR) model. They use monthly data from January 2000 to December 2016
for the Bombay Stock Exchange (BSE) index and the US Federal Funds rate (FFR) as a proxy for US
interest rates. The authors find that the US interest rate has a significant impact on the Indian stock
market returns. Specifically, they find that a one percent increase in the US interest rate leads to a 1.45
percent decrease in the Indian stock market returns, while a one percent decrease in the US interest rate
leads to a 1.37 percent increase in the Indian stock market returns. The authors also find that the impact
of the US interest rate on the Indian stock market is stronger during periods of high volatility.

Additionally, the authors find that other global factors such as crude oil prices, exchange rates, and
inflation have a significant impact on the Indian stock market returns. They suggest that investors in the
Indian stock market need to pay attention to the US interest rate movements as well as other global
factors as they can significantly impact the returns.

Overall, the study suggests that US interest rate changes have a significant impact on the Indian stock
market, and investors in the Indian stock market should consider global economic factors when making
investment decisions.

21
 Bhanumurthy, N.R. and Chakraborty, L. (2019). The impact of global and domestic shocks on
Indian stock market returns: A study using GARCH models. Journal of Quantitative Economics, 17(1),
107-132.

This study examines the impact of global and domestic shocks on Indian stock market returns using
Generalized Autoregressive Conditional Heteroskedasticity (GARCH) models. The authors find that
both global and domestic shocks significantly impact the Indian stock market returns, with the global
factors having a stronger impact. They also find that the impact of global factors varies based on the type
of shock and the sector of the economy.The authors suggest that investors in the Indian stock market
need to pay attention to both global and domestic factors as they can significantly impact the returns.
They also suggest that policymakers need to consider both global and domestic factors when formulating
policies that impact the Indian stock market.Overall, the study highlights the importance of considering
both global and domestic factors when analysing the Indian stock market returns and making investment
decisions

The Reserve Bank of India (RBI) conducted a study in 2016 titled "Transmission of External
Shocks through Non-resident Holdings of Domestic Bonds: Assessment of Channels and Magnitudes"
which analysed the impact of US Fed monetary policy on India's economy.

The study found that changes in US Fed interest rates had a significant impact on India's economy
through various channels, such as exchange rates, capital flows, and the cost of borrowing. Specifically,
the study suggested that a 100-basis-point increase in the US Fed rate could lead to a decline of 15-20
basis points in India's GDP growth rate. The study also analysed the impact of non-resident holdings of
Indian bonds on India's economy. It found that foreign investors' holdings of Indian bonds had increased
significantly in recent years, making India more vulnerable to external shocks. The study suggested that
the increased presence of foreign investors in the Indian bond market could amplify the spillover effects
of US monetary policy on India's economy. The RBI study recommended that India adopt a
comprehensive policy framework to manage the spillover effects of US monetary policy on its economy.
This framework could include measures such as building up foreign exchange reserves, improving the
quality of fiscal policies, and enhancing the efficiency of financial markets. Overall, the RBI study
highlighted the importance of understanding the spillover effects of US monetary policy on India's
economy and the need for policymakers to adopt a proactive approach to manage these spillover effect

The Reserve Bank of India (RBI) conducted a study in 2016 titled "Transmission of External
Shocks through Non-resident Holdings of Domestic Bonds: Assessment of Channels and Magnitudes"
which analysed the impact of US Fed monetary policy on India's economy. The study found that changes

22
in US Fed interest rates had a significant impact on India's economy through various channels, such as
exchange rates, capital flows, and the cost of borrowing. Specifically, the study suggested that a 100-
basis-point increase in the US Fed rate could lead to a decline of 15-20 basis points in India's GDP
growth rate. The study also analyzed the impact of non-resident holdings of Indian bonds on India's
economy. It found that foreign investors' holdings of Indian bonds had increased significantly in recent
years, making India more vulnerable to external shocks. The study suggested that the increased presence
of foreign investors in the Indian bond market could amplify the spillover effects of US monetary policy
on India's economy. The RBI study recommended that India adopt a comprehensive policy framework
to manage the spill over effects of US monetary policy on its economy. This framework could include
measures such as building up foreign exchange reserves, improving the quality of fiscal policies, and
enhancing the efficiency of financial markets.

Overall, the RBI study highlighted the importance of understanding the spillover effects of US monetary
policy on India's economy and the need for policymakers to adopt a proactive approach to manage these
spills over effects.

23
 CHAPTER 4: RESEARCH METHODOLOGY

Research Design:

In view of the great significance of appropriate research design to achieve the objectives of the research,
due attention has been given to research design for research problem under study.

An explanation of the different elements of research design adopted for the study is given as:

Sources of data:

The proposed study is entirely based on secondary data. The data has been collected from of the official
site of The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) and
another source for Indian economic factor is Reserve bank of India’s official site where all the historical
data is available in numeric format. Some data are collected from official site of International Monetary
fund . The average value of the yearly data has been calculated. For getting the accurate data in numerical
format yearly data of various economic factors had been taken for the study.

Test Applied:

To determine whether the Fed interest rate having an impact on various microeconomic factors, linear
regression has been performed. In linear regression the Fed interest rate is taken as independent variable
and there are many dependent variables such as , Indian Repo Rate, Inflation Rate, GDP Growth rate,
Bank rate, CRR and currency exchange rate. An individual regression test had been performed to find
the significance between two variables.

Software used:

To performed the linear regression the IBM SPSS statistics data editor software used while doing the
analysis.

24
 CHAPTER 5: Data Analysis

Dependent Variable: Indian Repo Rate

Independent Variable: Fed interest rate (Federal Fund Effective rate)
Variable Name Beta T value Significance

Repo Rate 0.321 2.175 0.041 (< 0.05)

Analysis:
Here, the Fed interest rate significantly affect the dependent variable (Repo Rate) at 5% level of
significance and 95% confidence level. As the significance value for dependent variable is less than
0.05. (0.041< 0.05).Hence the fed interest rate is significantly affecting the Repo rate.

In this case the null hypothesis is rejected and alternate hypothesis is accepted because the fed interest
rate is significantly (95% confidence level) affecting the Repo rate.

Summary: Fed interest rate has been significantly affecting the Repo rate. When the Federal Reserve
increases its interest rates, it becomes more expensive for banks in the United States to borrow money.
As a result, they may reduce their lending to other countries, including India. This reduction in lending
can lead to a decrease in the supply of funds available for banks in India, causing the repo rate to increase.

In addition, an increase in the Federal Reserve's interest rate can also lead to a strengthening of the US
dollar, which can make Indian exports less competitive and reduce foreign investment in India. This can
cause a decrease in the supply of funds available for Indian banks, again leading to an increase in the
repo rate. If RBI does not increase Repo rate, then it can reduce the foreign investment in India. Because
the investor will shift their investment to USA to get better returns.

Dependent Variable: Inflation Rate

Independent Variable: Fed interest rate (Federal Fund Effective rate)
Variable Name Beta T value Significance

Inflation Rate -0.503 -1.888 0.072(< 0.10)

25
Analysis:

Here, the Fed interest Rate is significant to the dependent variable (Inflation Rate) at 10% level of
significance and at 90% confidence level. As the significance value for dependent variable is less than
0.10 (0.072< 0.10) Hence the fed interest rate significantly affects to the Inflation Rate in India.

In this case the null hypothesis is rejected and alternate hypothesis is accepted because the fed interest
rate is significantly (90% confidence level) affecting the Inflation Rate in India.

Summary:
The Federal Reserve's interest rate can indirectly affect the inflation rate in India through its impact on
global financial markets and the Indian economy. When the Federal Reserve increases its interest rates,
it becomes more expensive for banks in the United States to borrow money. This can lead to a reduction
in lending and investment, which can slow down the global economy. As a result, demand for goods and
services can decrease, which can cause a decrease in global commodity prices, including oil.

Since India is a net importer of oil, a decrease in global oil prices can help to reduce inflationary pressures
in India. This is because oil is a key input in the production of many goods and services, and a decrease
in oil prices can lead to lower production costs and prices. But to import the oil, India has to pay in dollar
which is already very high in value when fed increases its interest rate so it can cause Imported Inflation
in India.

Dependent Variable: Real GDP Growth

Independent Variable: Fed interest rate (Federal Fund Effective rate)

Variable Name Beta T value Significance

Real GDP 0.067 0.177 0.861

Growth

Analysis:
Here, the Fed interest Rate does not affect the dependent variable (Real GDP Growth) at any level of
significance. As the significance value for dependent variable is more than 0.10.(0.861). Hence the fed
interest rate is not significantly affected Real GDP Growth of India.

In this case the null hypothesis is accepted and alternate hypothesis is rejected.

26
Summary: The Federal Reserve's interest rate can indirectly affect the GDP growth rate in India through
its impact on global financial markets and the Indian economy.

In addition, an increase in the Federal Reserve's interest rate can lead to a strengthening of the US dollar,
which can make Indian exports less competitive and reduce foreign investment in India. This can also
contribute to a slowdown in economic growth in India. But the fed interest rate is very less affecting
factor in GDP growth of India because the most important factors influencing GDP Growth in India is
Strong government policies, Infrastructure development, Education and skills development,
Technological advancements, Favourable demographic trends. Hence the fed interest rate is not showing
its permanent effect on GDP Growth rate hence they not significant.

Dependent Variable: CRR (Cash reserve ratio)

Independent Variable: Fed interest rate (Federal Fund Effective rate)
Variable Name Beta T value Significance

CRR 0.403 3.828 < 0.001

Analysis:

Here, the dependent variable (CRR) and independent variable are highly significant at 1% significant
level and 99% confidence level. Hence the fed interest rate is significantly affecting the Cash Reserve
Ratio (CRR).

In this case the null hypothesis is rejected and alternate hypothesis is accepted because the fed interest
rate is significantly (99% confidence level) affecting the CRR.

Summary:

When the fed interest rate increases the Indian Rupees, value get depreciated against US Dollar. If there
is a decrease in foreign exchange reserves, the RBI may need to reduce the CRR to inject liquidity into
the banking system and support economic activity. This is because a reduction in the CRR can increase
the amount of money that banks can lend, which can increase economic activity.

Conversely, if the Federal Reserve lowers its interest rate, it can stimulate borrowing and investment,
which can lead to an increase in foreign investment in India, contributing to an increase in foreign

27
exchange reserves. This can lead to an increase in the CRR as the RBI may need to reduce liquidity in
the banking system to prevent inflationary pressures.

Dependent Variable: Bank Rate

Independent Variable: Fed interest rate (Federal Fund Effective rate)
Variable Name Beta T value Significance

Bank rate -0.15 -0.107 0.961

Analysis:

Here, the dependent variable Bank Rate and independent variable (Fed interest rate) are not significant.
Because the significant value is more than (0.05 and 0.10) it is 0.961. Hence the fed interest rate is not
significantly affecting the Bank Rate.

In this case the null hypothesis is accepted and alternate hypothesis is rejected.

Summary:

The Bank Rate is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks
in India. It is an important monetary policy tool used by the RBI to regulate the money supply in the
country. The Federal Reserve's interest rate can indirectly affect the Bank Rate. The degree of impact
may vary depending on a range of factors, including the prevailing economic conditions in India and
global financial markets. The RBI sets the Bank Rate based on a variety of domestic factors such as
inflation, economic growth, and liquidity conditions in the Indian financial system. Therefore, changes
in the Federal Reserve's interest rate may not always have a direct impact on the RBI's Bank Rate.

Bank rate get affected indirectly as decrease in foreign exchange reserves, the RBI may need to increase
the Bank Rate to reduce the supply of money in the banking system and prevent inflationary pressures.
This is because an increase in the Bank Rate can make borrowing more expensive, which can reduce the
amount of money that banks can lend, and decrease economic activity.

28
 CHAPTER 6 :Conclusion And Suggestion

Conclusion :

This study has highlighted the impact of the US Federal interest rate on the Indian economy. This study
reveals that changes in US interest rates do have a significant impact on various macroeconomic and
microeconomic factors in India. These impacts include Repo rate, Inflation Rate, GDP Growth rate,
Bank rate. While performing linear regression, Fed interest rate is taken as independent variable and
Repo rate, Inflation Rate, GDP Growth rate, Bank rate are the dependent variable. This regression
analysis gives the significance between dependent variable and independent variable. An increase in the
US Federal interest rate will lead to a decrease in foreign investment in India and a subsequent decrease
in the Indian economy, while a decrease in the US Federal interest rate will lead to an increase in foreign
investment in India and a subsequent increase in the Indian economy.

The regression analysis shows some findings:

When the linear regression is performed between Repo rate (Dependent variable) and Fed interest
rate(independent variable ) the result shows there is positive significance between the variables and the
variable are significant at 5% significance level or 95% confidence level.

Later, when the linear regression is performed between Inflation Rate (Dependent variable) and Fed
Interest (independent variable) the result shows there is positive significance between the variables and
the variable are significant at 10% significance level or 90% confidence level.

When the linear regression is performed between GDP Growth Rate (Dependent Variable) and FED
Interest (Independent variable) the result shows there is no significance between the variables.

When the linear regression is performed between the Bank Rate (Dependent variable) and FED Interest
(independent variable) the result shows there is no significance between the variables.

However, the impact of the US Federal interest rate on the Indian economy is not entirely negative. For
example, a rise in the interest rates can lead to an increase in the returns on Indian investment products,
which can lead to more investments in the Indian market, boosting the economy. Additionally, the Indian
government can take measures such as increasing foreign reserves and controlling inflation to mitigate
the negative effects of the US Federal interest rate. Moreover, this study has shed light on the significant
implications of the US Federal interest rate for India's macroeconomic policy. The Indian government
and businesses need to understand and analyze the impact of the US Federal interest rate on the economy

29
to take proactive measures to manage it effectively. This study emphasizes the importance of coordinated
policy responses to mitigate the negative effects of the US Federal interest rate on the Indian economy.

While the impact is primarily negative, proactive policy measures can help mitigate the effects of the
US Federal interest rate. Thus, policymakers, economists, and investors must remain vigilant of the
evolving global economic landscape to make informed decisions that drive sustainable economic growth
and development.

Overall, the study indicates the importance of considering the global economic landscape and the role
of the US Federal Reserve in shaping the economic outcomes of emerging economies like India.

Overall, it is clear that the US Federal interest rate has a considerable impact on the Indian economy.
Understanding this impact and taking proactive measures to manage it is critical for the Indian
government and businesses to sustain economic growth and stability.

Suggestion:

Diversify the Indian economy: By diversifying the economy and reducing reliance on a particular
sector or market, India can become less vulnerable to external factors such as changes in the US Federal
interest rate. This can be done by investing in various sectors and markets, such as manufacturing,
services, agriculture, and technology.

Strengthen the Indian financial system: A strong financial system can better withstand the impact of
external shocks. The Indian government could take steps to ensure that the country's banking system is
resilient and well-regulated, and that financial institutions are adequately capitalized.

Encourage foreign investment: To counter the potential decrease in foreign investment caused by an
increase in the US Federal interest rate, India could take steps to attract more foreign investment. This
could include offering incentives such as tax breaks, streamlining bureaucratic processes, and creating a
more business-friendly environment.

Maintain a stable exchange rate: To mitigate the impact of changes in the US Federal interest rate on
the Indian economy, the Indian government could aim to maintain a stable exchange rate. This can be
done by managing inflation, maintaining adequate foreign exchange reserves, and implementing policies
to control capital outflows.

Enhance regional economic cooperation: By enhancing regional economic cooperation with

neighbouring countries, India can create new markets for its goods and services, which can help offset

30
any negative impacts caused by changes in the US Federal interest rate. This can be achieved through
initiatives such as trade agreements, joint ventures, and economic partnerships.

31
 CHAPTER 7: References

Ahmad, J., & Bhattacharyya, R. (2017). The impact of US monetary policy on India's economy. Journal
of Policy Modelling, 39(6), 1065-1084. doi: 10.1016/j.jpolmod.2017.07.005.
Bhanumurthy, N.R. and Chakraborty, L. (2019). The impact of global and domestic shocks on Indian
stock market returns: A study using GARCH models. Journal of Quantitative Economics, 17(1), 107-
132.
Bhatia, V., & Kumar, S. (2020). Impact of US monetary policy on Indian bond yields: An empirical
analysis. Journal of Public Affairs, 20(2), e2002.
Board of Governors of the Federal Reserve System (US), Federal Funds Effective Rate [RIFSPFFNA],
retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/RIFSPFFNA,
April 8, 2023.
Board of Governors of the Federal Reserve System (US), Interest Rate on Reserve Balances [IORB],
retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/IORB, April
8, 2023.
Dash, S., & Maitra, D. (2018). Impact of US interest rates on the Indian stock market: Evidence from a
VAR model. Journal of Quantitative Economics, 16(1), 147-161.
Dua, J., & Goyal, R. (2019). Monetary policy transmission in India: A DSGE approach. Journal of
Quantitative Economics, 17(3), 465-496. doi: 10.1007/s40953-018-0126-5.
Kumar, S., & Singh, A. (2021). US Federal Reserve interest rate changes and Indian microeconomic
factors: A review and empirical analysis. International Journal of Economics and Business Research,
21(3), 347-360.
Mohan, R. (1991). The Impact of US Interest Rates on Capital Flows to India. Economic and Political
Weekly, 26(8), 421-426.
Nitsure, R. R. (2012). Impact of the US monetary policy on India. RBI occasional papers, 33(1), 1-32.
Reserve Bank of India. (2016). Transmission of External Shocks through Non-resident Holdings of
Domestic Bonds: Assessment of Channels and Magnitudes. Retrieved from
https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=38202
Singh, T., & Giri, R. (2016). The impact of US federal funds rate on the Indian economy: A structural
VAR approach. Journal of Policy Modeling, 38(2), 375-389.
Tariq, A., & Gupta, M. (2017). US interest rates and Indian stock prices: A review and empirical
analysis. Journal of Economics and Political Economy, 4(4), 416-434.
Tiwari, A. K., & Vashistha, P. (2020). The impact of US Federal Reserve interest rate changes on the
profitability of Indian banks. International Journal of Financial Engineering, 7(03), 2050024.
Yadav, K., & Yadav, N. (2017). Impact of US monetary policy on India's stock market: A vector error
correction model approach. Journal of Quantitative Economics, 15(2), 253-270. doi: 10.1007/s40953-
016-0052-2.

32
https://dbie.rbi.org.in/BOE/OpenDocument/1608101729/OpenDocument/opendoc/openDocument.face
s?logonSuccessful=true&shareId=0
https://www.imf.org/external/datamapper/PCPIPCH@WEO/ADVEC/IND
https://www.imf.org/external/datamapper/PCPIEPCH@WEO/ADVEC/IND?year=2023
https://www.imf.org/external/datamapper/NGDP_RPCH@WEO/ADVEC/IND?year=2023
https://dbie.rbi.org.in/BOE/OpenDocument/1608101729/OpenDocument/opendoc/openDocument.face
s?logonSuccessful=true&shareId=0
https://ppac.gov.in/prices/international-prices-of-crude-oil
https://www2.deloitte.com/us/en/insights/economy/us-economic-forecast/united-states-outlook-
analysis.html
https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/MPRAPR2023CE7252C3A2594B408162BF7877E
F7F03.PDF

33