The Fed’s rate-hiking trajectory imposes two sets of constraints on central bank actions in the rest of the world. Reversing capital flows would require concerted policy interventions to keep currency and debt markets orderly. A rapidly cooling US economy, on the other hand, would pull down commodity prices that have surged on supply disruptions. The dollar index is at a two-decade high and crude futures slipped in anticipation of the Fed’s latest rate hike.
India will be affected as its largest trading partner exports recession. Portfolio investment outflows are likely to accelerate and borrowing costs will remain elevated. The rupee will be under pressure, which can benefit merchandise exports, but costlier crude imports are likely to widen the trade deficit. Services exports, more than merchandise, are vulnerable to a US recession. This, in turn, affects foreign direct investment into information technology. India has, in the recent past, been importing inflation. With China, its second-largest trading partner, still facing a slowdown, there could be both supply and demand effects on growth. This would come at just about the time domestic demand has recovered from the pandemic. Both monetary and fiscal interventions have been alive to the evolving external environment.