US Federal Reserve’s Rate Cut: Impact on India

The United States Federal Reserve has announced a quarter-percentage-point cut in interest rates. This was the first-rate cut in 11 years- the first since the global financial crisis broke in 2008.

The rate cut marked a departure from the hawkish rate-hike trajectory of US Federal Reserve moving in the direction of bolstering the debt-laden American economy.

Why Rate Cut?

The Fed has announced the rate cut due to:

• Concerns about the global economy and muted US inflation.
• There was also pressure from the US president for a cut in rates to stoke growth.

Impact on Emerging Economies

• A rate cut in the US is traditionally seen as a positive for emerging market economies (EMEs), especially from a debt market perspective.
• India and other emerging economies tend to have higher inflation and, consequently higher interest rates than those in developed countries such as the US and Europe.
• This gives stimulus to trend wherein Foreign Institutional Investors tend to borrow money in the US at low-interest rates in dollar terms, and then invest that money in bonds of emerging countries such as India in rupee terms to earn a higher rate of interest.
• The US Fed rate cut increases the difference between the interest rates of the two countries. This makes India more attractive for the currency carry trade.
• A rate cut by the Fed would also mean a greater impetus to growth in the US, which could be positive news for global growth. But this could also translate into more equity investments in the US, which could temper investor enthusiasm for emerging market economies in a proportionate manner.

The US Fed has clearly stated that the rate cut was a mid-cycle adjustment to policy”, thus ruling out multiple sequenced cuts in rates. Hence India must strengthen its macro-economic credentials and must augment the infrastructure to attract the FIIs or else India would miss an opportunity.