Impact of US Fed Interest Rate Decisions on the Indian Stock Market

The Indian stock market is significantly influenced by the decisions of the US Federal Reserve, especially its “interest rate policies”. Whenever the US Fed announces changes, even a slight increase or decrease in interest rates can cause notable fluctuations in Indian stocks. This high sensitivity is because these rate changes affect foreign investments. A rise in US rates can make it more attractive for investors to pull funds out of India, while a decrease may encourage them to invest more.

Foreign Portfolio Investors (FPIs) invested a record ₹2.74 trillion (around $37 billion) in the Indian stock market during FY21. This substantial inflow significantly supported the benchmark indices, leading to their strongest single-year growth in a decade. Foreign ownership in Indian equities also rose to 27.6%, notably higher than the long-term average of 19.6%.

In this article, we will explain in detail why and how US Fed interest rate changes affect the stock market. We will cover both scenarios of rate hikes and cuts.

US Fed interest rate changes affect the stock market through both a rate hike and a rate cut. Let’s see how a US Fed rate hike works:

• Less attractive Indian markets

When US rates go up, foreign investors pull their money out of Indian markets. This is because the returns from the US (like government bonds) become more appealing than the Indian stock market. Hence, foreign investors move their money from India back to the US.

• Weaker Indian rupee

Be aware that the US dollar strengthens due to higher interest rates and the rupee weakens. Now, this causes foreign investors to get less return when they convert their investments from rupees back to dollars. Such a situation discourages them and they often decide to shift investments to better markets. 

• Short-term investors sell their investments

While long-term investors might stay, those who are investing for the short term usually pull out. A weaker rupee and volatile markets make it harder for them to manage their investments. This reduces their returns and most prefer to square off their positions.