How US Fed Rate Cut Will Impact The Indian Economy?

The US Federal Reserve made waves on Wednesday by cutting interest rates by 50 basis points, marking the first reduction in over 4 years. In its announcement, the Federal Open Market Committee (FOMC) noted, “In light of progress on inflation and the balance of risks, the Committee decided to lower the target range for the federal funds rate by 1/2 percentage point to 4.75% to 5%.” This decision signals a significant policy shift aimed at easing the previously tight monetary conditions used to combat inflation.

What This Means for Borrowing

This rate cut is set to lower borrowing costs for consumers and businesses alike, making loans for mortgages, auto purchases, and credit cards more affordable. As a result, we expect an uptick in spending and investment, which could invigorate the economy. The impact of this decision won’t just be felt in the US; it’s likely to resonate around the globe, particularly in emerging markets like India.

Boosting Foreign Investment in India

One of the most immediate effects of the Fed’s rate cut is a potential surge in foreign investment in India. When US interest rates are elevated, investors flock to US Treasury securities for their attractive returns. But with the recent cut, those yields will diminish, prompting a shift in focus toward more lucrative opportunities in Indian equities and debt markets. This influx of foreign capital could significantly boost demand for Indian stocks and bonds, likely driving up their prices.

Currency Dynamics at Play

As foreign investors convert their currencies into Indian Rupees (₹) to seize these investment opportunities, we can expect an increase in demand for the rupee, potentially leading to its appreciation against the US dollar. While a stronger rupee may lower the cost of imports—particularly vital commodities like oil—it could pose challenges for Indian exporters, making their goods pricier for overseas buyers.

Bond Market Reactions

Globally, lower interest rates often trigger a rally in bond markets, and India is no exception. Existing bonds may become more attractive as their yields appear favourable compared to new issues. This could lead to decreased borrowing costs for both the government and corporations, encouraging capital investments and stimulating economic growth.

Sector-Specific Gains

Certain sectors stand to gain directly from the Fed’s rate cut. The information technology (IT) sector, for example, may see a boost as US companies increase their IT budgets in response to reduced borrowing costs. Other sectors, including consumer goods and infrastructure, could also thrive as cheaper financing becomes available.

RBI Response

The RBI’s response to the Fed’s actions will be crucial. Historically, Indian monetary policy has been influenced by US rates. However, RBI governor Shaktikanta Das has already signalled that India is not compelled to follow suit and reduce its own rates.

The governor emphasised that maintaining financial stability remains a top priority for the central bank. “Financial stability is a prime consideration,” Das said, highlighting the importance of ensuring a robust and resilient financial system.

Conclusion

The Fed’s rate cut is not just a local event; it sets off a chain reaction with global implications, particularly for emerging markets like India. As borrowing costs decrease, opportunities for investment and growth could flourish, though careful navigation will be necessary to balance stability and expansion.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.