The United States of America is the central bank of the world. Everyone watches statements emanating out of the US Federal Reserve like a hawk. Jerome Powell, the chairman of the top central bank, said that the time was ripe for the US to make policy adjustments. That means America will move towards reducing interest rates hiked rapidly soon after the COVID-19 pandemic. It will be a gradual process to ensure that the US economy continues to grow without fears of any inflationary pressures.
The interest rate policy action directly affects foreign flows into emerging markets. As the US reduces borrowing rates, money flows from assets denominated in the US dollar to emerging markets. With a strong hint about rate cuts, money would start moving swiftly. That causes asset prices across non-US markets to rise. Investors flock to low-value equity, commodity or property markets.
Much commentary talks about India being a destination preferred by investors moving out of underperforming markets like China. However, share prices in India are already sky-high. They are trading at a record-high valuation compared to previous years. That means expectations of future profits in India are already in the current market price. As a result, analysts are highly cautious about Indian equities. For Indian shares to do well, profits must grow faster than now.
The minutes of the Reserve Bank of India’s monetary policy committee meeting published last week show that listed private manufacturing companies show sales and profits softened in the first quarter of fiscal year 2024-25. Consumer confidence fell, and the business expectations index has moderated since the previous quarter. In its outlook, RBI has reduced the first-quarter growth forecast.
Within RBI’s monetary policy committee, calls for rate cuts are rising. Professor Jayanth R Varma and Ashima Goyal, the two members of the committee, called for a cut in the repo rate, the rate at which RBI lends money to the banks. However, the committee voted to keep borrowing rates unchanged due to fears of a surge in food inflation contributing to consumer price inflation.
However, financial markets need faster economic growth. High interest rates stall any future business expansion, affecting profits. While government expenditure could surge in the infrastructure sector and boost economic activity, India needs private investment to add to the economic growth. In 2025, the RBI may have to consider reducing borrowing rates.
What it means to your money
Interest rates in India are unlikely to go down quickly. India’s borrowing rate cuts are likely to lag that of the US. That means you will continue to enjoy high returns on your fixed deposits. Equity markets will likely remain stagnant until businesses show faster profit growth. The money flowing into equity markets through mutual funds and the Life Insurance Corporation of India will likely create a bottom for the markets. That means share prices are unlikely to fall significantly even as prospects for a rapid rise in share prices could diminish.
A phase of stagnancy in financial markets is not such a bad thing. You can spend a lot of time learning about the impact of monetary policy on the economy and the economy of the listed companies. This is an excellent time to work with a financial advisor and understand the interplay between global interest rates, India’s economy and your money. You need to build your investment team. If you already have an advisor, you must enhance the scope of your engagement with them by asking questions. You must learn about financial flows influenced by monetary policy or macroeconomics. If you are uninterested to dive deep, you should resort to passive investing through a broader index fund or an exchange-traded fund.
Diversify your money according to your ability to know things. If you have the bandwidth to learn about risks and returns equations, you should enhance your allocation to equities. However, if you find learning about finance challenging, continue to hold on to your gold, property, life insurance policies, fixed deposits, public provident funds and guaranteed pension funds.