Explained: How will the red-hot inflation in US impact India?

On September 13, the US government said inflation rose 8.3 percent on a year-on-year basis in August. In May, the US inflation stood at 8.6 percent and rose to 9.1 percent in June. It later fell to 8.5 percent in July. Although US inflation data was expected to show a declining trend, core inflation may continue to be a worry for economists, analysts, and stock market investors.

Historically, long-term inflation has resulted in a recession in the US. Scrambling to bring down inflation, the US Federal Reserve will look at increasing interest rates. Stock market investors react strongly to changes in key interest rates. Hence, Indian investors can expect a change in their investment portfolio. Growth stocks are mostly impacted by the changes in interest rates as their fund managers use a discounted cash flow model to assign values to these stocks. As interest rates go up, fund managers tend to assign a lesser value to growth stocks.

A rise in the cost of goods in the US leads to a rise in the prices of these goods imported by India. Apart from commodities like edible oils and pulses, prices of fuel get affected by the increase in US inflation. An increase in the price of energy is a worry for the government as India is a net importer of crude oil and has to pay huge bills for buying it.

With the rise in interest rates, investors will start pulling out money from riskier investments like equities, commodities and foreign markets. A flight of foreign portfolio investors (FPIs) from the equity and bond markets could further weaken the rupee even as the dollar gets stronger with the rate hikes.

Earlier this month, Moody's Investors Service maintained a sovereign rating on India at Baa3 with a stable outlook, saying that the impact of the Russia-Ukraine war, high inflation and global financial conditions are unlikely to impact the country's recovery from the COVID-19 pandemic.

“With higher capital buffers and greater liquidity, banks and nonbank financial institutions (NBFIs) pose much less risk to the sovereign than we previously anticipated, facilitating the ongoing recovery from the pandemic,” the rating agency said.

In a press note, the agency said the current economic environment of the country could result in a gradual reduction in the general fiscal deficit over the next few years. However, it listed higher debt burden and weak debt affordability as some risks.