NEW DELHI: The US Federal Reserve reduced interest rates by 50 basis points on Wednesday, marking the first cut in over four years. In its statement, the Federal Open Market Committee (FOMC) said, “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 move signals the beginning of a policy shift to ease the restrictive conditions previously implemented to control inflation.
The Fed’s decision will lower the rates at which commercial banks lend to consumers and businesses, reducing the cost of borrowing across a range of financial products, including mortgages, auto loans, and credit cards. This cut is expected to make borrowing more affordable, stimulating spending and investment.
The ripple effects of the Fed rate cut will be felt globally, particularly in emerging markets like India.
Impact on foreign investment
One of the most immediate likely effects of the rate cut is the potential increase in foreign investment in India. When US interest rates are high, investors tend to favor US Treasury securities for their relatively higher returns. However, with a rate cut, yields on these securities will decrease, prompting investors to seek better returns elsewhere, including in Indian equities and debt markets. This shift could lead to a substantial inflow of foreign capital into India, driving up demand for Indian stocks and bonds, which may subsequently increase their prices.
Currency dynamics
The influx of foreign capital is also likely to affect the Indian Rupee (INR). As foreign investors convert their currencies into INR for investment purposes, demand for the rupee will rise, potentially leading to its appreciation against the US dollar. A stronger rupee can have mixed effects; while it may lower the cost of imports (especially crucial commodities like oil), it could also negatively impact Indian exporters by making their goods more expensive for foreign buyers.
Bond market reactions
Globally lower interest rates typically lead to a rally in bond markets. In India, this could mean that existing bonds become more attractive as their yields appear favorable compared to new issues. Consequently, this dynamic may lower borrowing costs for both the government and corporations, encouraging more capital investments and stimulating economic growth.
Sectoral impacts
Certain sectors are poised to benefit directly from the Fed’s rate cut. For instance, the information technology (IT) sector may see increased demand as US corporations expand their IT budgets due to reduced borrowing costs. Additionally, other sectors such as consumer goods and infrastructure could also experience growth as cheaper financing becomes available.
RBI’s policy 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 signaled that India is not compelled to follow suit and reduce its own rates.
The governor emphasized 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.
Das’s comments suggest that the RBI will carefully assess the domestic economic conditions and potential risks before making any decisions on interest rates.
(With inputs from agencies)