The US Federal Reserve has reduced its policy rates by 50 basis points, the first cut in over four years. The bigger-than-expected reduction marks the beginning of a much-awaited pivot and eases the tight monetary conditions that were aimed at bringing inflation down from a 40-year high of 9.1 percent in 2022. Prices are steadily cooling down, and the latest rate cut is seen as the US central bank’s victory over inflation. Lending rates had touched a two-decade high of 5.3 percent after July 2023. Now, borrowing will be more affordable, stimulating spending and investment. The Fed is likely to trim rates by another 50-75 bps by the end of the year; another percentage-point reduction is expected each in 2025 and 2026. It’s not just the Fed—all major central banks are launching into a rate easing cycle. The European Central Bank has cut rates by 50 bps since June, while the Bank of England, which first cut rates in August, is expected to announce more cuts.
Though the Fed’s rate changes are valid within US jurisdiction, but their impact is often felt globally, particularly in emerging markets like India. The immediate effect will be seen through more foreign investment flows into India as investors flee the US market in search of higher returns. While a higher foreign capital inflow is welcome, it will drive up demand for Indian equities and bonds, besides increasing the demand for the rupee, potentially leading to its appreciation against the US dollar. A stronger rupee, in turn, will lower the cost of imports; but it will also affect Indian exporters, which isn’t desirable given India’s ambitions to emerge as a global export hub. Rate cuts not only weaken the dollar but also firm up the prices of commodities like crude oil, which is a negative for oil-importing countries like India.
That said, all eyes are now on the RBI, which has been maintaining that its policy decisions will not mirror those in the US, but will be purely driven by domestic factors. It had last cut the repo rate by 40 bps to 4 percent in May 2020, and then increased it by a staggering 250 bps to 6.5 percent to tame inflation. As Governor Shaktikanta Das has noted, maintaining financial stability should be a top priority.