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Oct

US Fed Rate Cut No Big Deal For Indian Economy

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Prof Shivaji Sarkar

New Delhi | Tuesday | 1 October 2024

The recent decision by the US Federal Reserve to cut interest rates by 50 basis points (0.5%) after a four-year hiatus has sparked a global conversation. However, for India, this move may not be as advantageous as some might hope. While the global markets react, India must carefully assess the associated risks, especially the potential decline in the value of the dollar and unpredictable trends in the global economy.

One of the most immediate concerns for India is the potential rise in domestic inflation. There are predictions that by October, inflation in India could hit around 5%, and this could complicate the Reserve Bank of India's (RBI) decision-making process. Although there has been ongoing pressure from the industry for the RBI to follow the US Federal Reserve's lead and cut interest rates, it seems unlikely that the RBI will make such a move in the near future. The RBI remains cautious, keeping a close watch on global volatility and other factors before making any decisions.

A recent report from the State Bank of India (SBI) Research also suggests that the RBI is not expected to cut rates this year. Instead, a potential rate cut could be announced as late as February 2025. The current situation in the US offers a glimpse into the complexities of such a decision. Some experts believe that if the US economy is struggling enough to prompt a rapid rate cut from the Fed, this could negatively affect the stock market. On the other hand, a slower, more gradual return to normal interest rates might not impact corporate profits as severely as an economic downturn would.

 

Article at a Glance
The US Federal Reserve's recent decision to cut interest rates by 0.5% has sparked a global conversation. However, for India, this move may not be as advantageous as some might hope.
The Reserve Bank of India (RBI) must carefully assess the associated risks, including the potential decline in the value of the dollar and unpredictable trends in the global economy. One of the most immediate concerns for India is the potential rise in domestic inflation, which could complicate the RBI's decision-making process.
The RBI remains cautious, keeping a close watch on global volatility and other factors before making any decisions. A rate cut is unlikely in the near future, and the RBI's priority should be to safeguard the interests of depositors and prioritize long-term stability over short-term gains.

 

However, it is important to remember that the stock market is not necessarily an accurate reflection of the overall economy. In fact, the stock market often operates on emotions and speculation, as seen in the recent rallies in India. The US rate cut has been received positively by financial institutions like Bloomberg, with many seeing it as a good move. Yet, the precise connection between the rate cut and rising share prices is not always clear.

For India, the appreciation of the rupee could pose further challenges, especially in terms of exports. In a competitive global market, a stronger rupee could mean that Indian exports become less lucrative when converted into dollars. This could also affect the value of India’s foreign exchange reserves held in dollars.

Despite these concerns, India appears to be somewhat insulated from the immediate effects of global rate movements, as pointed out by Foreign Secretary Ajeet Seth. The country’s economy is projected to grow, and inflation remains under control for now. The RBI’s Monetary Policy Committee will meet in October to discuss the global changes and their potential impact on India. However, it is unlikely that a rate cut will be announced at that time, especially given the different inflation scenarios between the US and India.

In the US, inflation has fallen from a high of around 9% to around 2%, which is still considered high by some standards. The Federal Reserve’s decision to cut rates was largely driven by pressure from industry and business, reflecting a global trend where governments are increasingly influenced by multinational corporations.

There are concerns that India may eventually face similar pressure to cut rates, regardless of whether the situation truly warrants it. Many observers believe that a rate cut could be on the horizon before the presentation of the Union Budget. In the short term, the stock market has reacted positively to the news of the US rate cut, with indices like the Bombay Stock Exchange’s Sensex and the National Stock Exchange’s Nifty showing gains.

However, lower interest rates are not a universal solution. While they can lower borrowing costs, this only applies from a future date. If the RBI does cut rates, it could make credit cheaper for both consumers and businesses. This might allow companies to expand and consumers to afford larger purchases, such as homes with lower mortgage rates. But there are also potential downsides to this.

The relationship between interest rates and the broader economy is complex and unpredictable. Lower rates do not always boost the economy, and in some cases, they can have negative effects on certain sectors, particularly the banking industry. Lowering interest rates beyond a certain point can be counterproductive. Banks may struggle to maintain profitability, as was seen during the 2007-2008 financial crisis. During that period, the US Federal Reserve began cutting rates in September 2007, but the stock market still fell by more than 20% over the next year.

India, too, has faced its share of challenges with rate cuts. During the 2008-2009 financial crisis, efforts to incentivize corporate investment led to a severe crisis in the public banking sector. Non-performing assets (NPAs) skyrocketed, leading to the restructuring and merger of several public sector banks. The Indian banking system has undergone numerous crises since then, and it is important for the RBI to tread carefully.

Ultimately, the RBI’s priority should be to safeguard the interests of depositors, rather than focusing solely on the needs of corporations. Inflation remains a significant concern, and raising interest rates might be a more prudent move in the coming months. This would benefit both the economy and depositors, who are currently seeing dwindling returns on their savings. While there is pressure from various vested interests, the country expects the RBI to make the right decision and prioritize long-term stability over short-term gains.

In conclusion, while the US Federal Reserve’s rate cut may have immediate effects on global markets, India must approach this situation with caution. The RBI’s decisions in the coming months will be crucial in determining the country’s economic trajectory, and it is essential that these decisions are made with a focus on stability and the broader public interest.

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