US Fed Slashes Interest Rate; First Since 2020: Impact on India

Intending to curb inflation, the US Federal Reserve lowered its key interest rate by 50 basis points, marking its first reduction since 2020.

This action by the US Federal Reserve indicates the onset of a shift in policy to ease the previously implemented restrictive measures to bring inflation under control.

The Federal Reserve's benchmark policy rate has stayed within the 5.25%-5.50% range for 14 months, which is longer than three of the last six instances when rates remained unchanged.

However, it is shorter than the 15-month pause witnessed before the 2007-2009 financial crisis and significantly below the 18-month hold during the late 1990s’ "Great Moderation."

Impact of rate cut on India

One immediate effect of this rate cut is the anticipated rise in foreign investment in India.

Investors typically prefer US Treasury securities due to their higher returns when the US interest rates are high.

However, with the recent cut, the yields on these securities are expected to decline, prompting investors to search for better returns in markets like Indian equities and debt.

This transition could result in a significant inflow of foreign capital into India, boosting demand for Indian stocks and bonds and potentially raising prices.

Currency dynamics will also change

The arrival of foreign capital is likely to influence the Indian rupee as foreign investors convert their funds into rupees for investment, increasing demand for the domestic unit and possibly leading to its appreciation against the US dollar.

While a stronger rupee can reduce import costs, it may also pose challenges for Indian exporters by making their products pricier for international buyers.

Lower interest rates globally usually trigger a rally in bond markets. In India, existing bonds could become more appealing as their yields become more favorable than new issues.

As a result, this situation may reduce borrowing costs for both the government and corporations, promoting increased capital investments and driving economic growth.

Certain sectors are particularly positioned to gain from the Fed's rate cut.

For example, the information technology (IT) sector may experience heightened demand as US companies boost their IT budgets due to lower borrowing expenses.

Additionally, sectors such as consumer goods and infrastructure may also witness growth as financing becomes more affordable.

Historically, Indian monetary policy has been affected by US rates. However, RBI governor Shaktikanta Das has indicated that India need not follow the US lead in reducing its own rates.

He stressed that prioritising financial stability is crucial for the apex bank.

Das underscored the importance of maintaining a strong and resilient financial system.