Fed raises rates: Why India could face a fresh FPI outflow risk

India could face fresh pressure from foreign investors after the US Federal Reserve raised interest rates and signalled another hike could follow. Higher US yields and a stronger dollar could make Indian assets less attractive at the margin.

The Fed raised its benchmark interest rate by 25 basis points on Wednesday to a range of 3.75 per cent to 4 per cent. It was the first US rate hike since 2023 and came as inflation remained above the central bank’s 2 per cent target.

The bigger signal for global markets was the Fed’s outlook. Its latest projections showed that 16 of 18 policymakers expect at least one more rate increase this year. The median projection puts the policy rate at 4.1 per cent at the end of 2026.

For India, the concern is what this means for the flow of global money.

Why the Fed matters for FPI flows

A higher US policy rate can push up Treasury yields and increase the return available on US dollar assets. If those yields remain elevated, global investors may become more selective about emerging markets.

The impact is not automatic. Investors also consider India’s growth outlook, corporate earnings, valuations, domestic liquidity and the expected return after accounting for currency movements.

But the relative attraction of Indian assets can weaken when US yields rise sharply.

More from Business

The US 10-year Treasury yield was around 5 per cent after the Fed decision, while the two-year yield also moved higher. The dollar strengthened after the announcement.

FPIs are already selling

The latest Fed move comes when foreign investors have already turned cautious towards Indian equities.

FPIs sold around Rs 14,475 crore of Indian equities in September through the middle of the month, according to market data reported this week. The selling followed buying in July and August and came as crude prices rose and global bond yields moved higher.

If Treasury yields rise further, investors may demand a higher return from Indian assets to compensate for the additional risk. That can put pressure on equity valuations, particularly in segments where valuations are high and future earnings account for a large part of the stock price.

Higher US yields can also reduce the yield advantage offered by Indian bonds to overseas investors.

The rupee is another channel

The rupee closed at Rs 95.9550 against the dollar on Wednesday after touching Rs 95.9750, its weakest level since late July. The currency has been under pressure from strong dollar demand, elevated oil prices and expectations of tighter US monetary policy. The Reserve Bank of India has been intervening to limit the pace of the decline, according to Reuters.

A weaker rupee can affect FPI returns because overseas investors ultimately measure their returns in dollar terms.

For example, an Indian equity investment can rise in rupee terms but deliver a smaller dollar return if the rupee depreciates against the US currency.

That is why currency stability can be as important as the interest-rate differential when foreign investors decide how much money to allocate to India.

Crude adds to India’s vulnerability

The Fed decision also comes against a difficult oil backdrop. Brent crude has remained above $100 a barrel as the conflict involving Iran disrupts supply expectations. India imports a large share of its crude oil requirements, making oil prices an important factor for the country’s trade balance, inflation and currency.

Higher crude prices increase India’s demand for dollars to pay for imports. If this happens alongside a stronger US dollar, pressure on the rupee can increase.

That can create a difficult combination for foreign investors because they face both market risk and currency risk.

What does it mean for the RBI?

The Fed does not dictate the Reserve Bank of India’s monetary policy. The RBI considers domestic inflation, economic growth, liquidity and financial stability when setting its own policy.

But global interest rates still matter. If US rates stay high and the dollar strengthens, the RBI may have less room to ignore pressure on the rupee and imported inflation. A narrower interest-rate differential can also affect foreign capital flows.

India’s benchmark 10-year government bond yield was already around 7 per cent as global yields rose and the RBI announced plans for open-market sales of government securities.

This means Indian bond markets are also facing pressure from both domestic and global factors.