RBI may disassociate from interest rate developments in the US

The Reserve Bank of India (RBI) is likely to disassociate from the interest rate developments in the US and may take independent view on the domestic rates based on the evolving conditions. The Fed’s 50 basis points action remains a minor one for the flows to equity markets, which place the Indian markets at a slightly overvalued pedestal. Bond markets may witness comparatively better inflows due to the continuation of the rate differentials trajectory as the RBI looks more set to depart from the ‘Follow the Fed’ mentality for good, having created a robust and resilient Indian financial ecosystem, fuelled largely by domestic demand-supply metrics. The USD/INR, however, may undergo some gravitational pull to sustain the country’s competitiveness on the trade front, despite a weakening dollar index. Moreover, the aggressive rate cut by Federal Reserve has important bearing on RBI’s own decision on interest rates. Although this is not explicit, as per Ecowrap, a fall in dollar rates impacts domestic inflation through international prices.

The recent minutes of the RBI MPC do indicate discussions on possible Fed rate actions. Domestic conditions are paramount and with robust growth higher than the potential output, a pause case still exists. This is further supported by the fact that the impact of a weak dollar on international prices and its pass through on Indian economy may evolve in the coming days. Additionally, a better liquidity position may provide the cushion to the central bank to let the festive season tide over. As such, the internal economists of State Bank of India (SBI) do not anticipate any rate action by RBI in calendar 2024. An early 2025 rate cut looks the best bet as of now. We still believe that liquidity challenges will remain for the banking sector with government cash balances progressively moving out of the banking system and inching towards JIT mechanism. For starters, even as Fed has cut rates by 50 basis points, the central bank may go for rate cut only in December and not during next month’s MPC meeting.

The US Fed cut the interest rate by 0.5 per cent for the first time in the last four years. Such high monetary correction was earlier undertaken only during the global financial crisis, which is indicative of the severity of the economic stress the US is going through. Decadal high inflation and stressed labour market conditions were the preamble for such aggressive monetary correction, says a report by Emkay. This will continue to add to uncertainty in the equity markets, which, incidentally, reacted negatively and ended in the red. Analysts see the broader emerging economies to undertake rate-cut decisions. The FII flows can be outbound in the short term and as the US dollar starts easing, the flows can come back into India. The markets are expected to remain in range with positively biased. As a case for an early cut is still less likely, analysts continue to see shallow cuts by both Fed and the RBI in this cycle.