In 2024, the U.S. Federal Reserve’s decision to cut interest rates has reverberated across global financial markets, eliciting a mixed response from various economies, particularly emerging markets like India. The implications of these cuts are significant and multifaceted, affecting everything from capital flows to inflation and economic growth.
This article delves into how the Fed’s rate cut impacts the Indian economy.
– Fed’s 50 bps Rate Cut
The Fed was expected to cut the interest rate in its September meeting as the Fed Chair said in public forums last month that the right time has come for the rate cut. A rate cut of 25 bps or 50 bps was on the cards. Majority believed that the Fed would go with a 25 bps rate cut.
To the surprise of most, the Fed decided to go for a 50 bps rate cut. It was the first interest rate cut since the early days of the Covid pandemic.
– Why did the Fed reduce the rate?
1. Stimulate Economic Growth
The Fed may cut interest rates to promote borrowing and investment if the economy is expanding too slowly or if a recession is a possibility. Reduced interest rates make loans more affordable for consumers and businesses, which can encourage job creation, raise corporate investment, and increase spending.
2. Financial Market Stability
In times of financial stress or instability—like during a financial crisis or a sharp market downturn—lowering interest rates can help stabilize the markets. Cheaper borrowing can ease liquidity concerns for businesses and banks and prevent broader financial disruptions.
3. Pre-emptive Action Against Economic Risks
The Fed may also reduce rates pre-emptively if it sees risks on the horizon, such as slowdowns in economic growth, rising unemployment, or other signs that the economy could weaken. By lowering rates early, the Fed hopes to support growth before a slowdown becomes more pronounced.
– Impact on the Indian Economy & Stock Market
1. Capital Flows and Foreign Investment
U.S. assets lose appeal when interest rates drop, especially bonds and other fixed-income investments with lower yields. Investors may therefore look for better profits abroad, such as in developing nations like India. Increased Foreign Portfolio Investment (FPI) inflows into Indian stocks result from this, which raises stock prices.
2. Rupee Appreciation
Fed rate cut often results in a weakening of the US dollar as investors move their money to higher-yielding economies like India. This may cause the Indian Rupee (INR) to appreciate against the US dollar. While a stronger rupee makes imports cheaper (beneficial for oil imports), it can hurt Indian exports, which become more expensive for foreign buyers.
3. Inflation
A stronger rupee resulting from higher capital inflows makes imports cheaper, reducing the cost of goods like crude oil, electronics, and other essential commodities. This can help reduce imported inflation in India.
4. The Monetary Policy of India
The Reserve Bank of India (RBI) has additional leeway in reducing interest rates thanks to the Fed rate drop. Capital flight from India to the US is less likely now that interest rates are lower in the US. By lowering the repo rate, the RBI can encourage domestic borrowing, investment, and consumption without having to worry about significant capital outflows.
5. Global Economic Interdependencies
Because of the interdependence of the world’s economy, shifts in U.S. monetary policy have a significant impact. A number of international issues, such as geopolitical tensions, changes in commodity prices, and the state of other major economies, could have an impact on India’s economy in 2024.
For instance, Indian exporters may profit from higher demand for imports if the Fed’s rate cuts boost U.S. GDP. On the other hand, the chances for Indian growth may be hampered if other economies experience difficulties. The Indian government must continue to be flexible and prepared to modify its economic policies in reaction to developments throughout the world.
6. Expected short-term volatility
Changes in US interest rates, which frequently cause changes in international markets, cause some short-term volatility in the Indian stock market, according to experts. Investors may respond to the uncertainty as a result. Nonetheless, India’s strong economic prospects may continue to draw in foreign capital, which could eventually help the stock market.
CONCLUSION:
The Fed rate cut is a positive sign for the emerging market like India. The Fed rate cut can provide a short-term boost to the economy. It is essential to monitor the evolving economic landscape and potential risks. The Indian government and Reserve Bank of India will need to carefully assess the situation and implement appropriate measures to mitigate any adverse effects.
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The article is authored by Ms. Ritika Sharma from Team RichVik.