The markets are calling it the ‘everything’ rally. US benchmark index S&P500 is hovering near its all-time high. The Nasdaq Composite and the Dow Jones Industrial Average reached new all-time highs mid-week. In India, the Nifty50 is yo-yoing around its high watermark of 22,526. Theory has it that there is a correlation between the prices of gold (and bitcoin) and stocks, and that seem to be unravelling. Gold prices touched a new high of $2,222.49 an ounce this month. Bitcoin, that enigmatic article of faith, is bouncing off its record price of $73,797 touched on March 14. It would seem the financial markets have discovered an antidote to gravity.
The gyrations in financial markets are riveted on estimations and expectations of the cost of money. Every central bank in the world is avowedly data dependent—effectively, this means they will cut or not cut rates on the basis of incoming data on inflation, employment and growth.
This week, the US Federal Reserve presented the summary of economic projections for 2024, 2025 and 2026. It is estimated that US GDP will grow at 2.1 percent—faster than the December estimation of 1.4 percent. Unemployment will not fall as previously expected. Inflation in March was at 3.2 percent, core inflation will hover at 2.6 percent and will persist well above target till 2026. Notwithstanding the reality, the federal funds rate is projected to dip to 4.6 percent from the current band of 5.25 to 5.5 percent.
Naturally, the market, thrilled with the projection, is expecting three rate cuts this year. But what explains the rationale for the expectation of a cut when none of the moving parts of the economy are flashing amber or red? The fall in inflation is engendered by supply side improvements—in the availability of goods and labour via an increase in immigration.
The euphoria in the markets is curious as the Fed rate curve continues to range between 3.4 and 4.1 percent even in 2025, which translates into a higher neutral rate. Fed Chair Jerome Powell, when asked about the gap between target and stance, observed, “Markets believe we will achieve that goal and they should believe that, because that's what will happen over time.” Even Alan Greenspan, who mystified markets with his articulation, would have been mystified!
Why does all this matter to India? Over three decades back, in February 1990, Don Brash at the Bank of New Zealand introduced the idea of targeting inflation at 2 percent. The usage of the phrase ‘over time’ by Powell suggest that the Federal Reserve is comfortable with a higher-than-targeted inflation. And what happens in the US does not stay in the US, as the Federal Reserve practically sets the tone. Indeed, a day later, Bank of England Governor Andrew Bailey signalled that rate cuts are on their way.
Tolerance for higher inflation effectively translates into a higher cost of capital the world over. This has implications for India and other developing economies. To start with, the higher-for-longer global regime dashes the hopes of those expecting the Reserve Bank of India to trim rates following the slide in core inflation—what was anyway unlikely in April may not happen in June either.
Currently, the RBI’s repo rate is at 6.5 percent, 10-year GoI bond yields are around 7 percent and prime lending rates are upwards of 9 percent. The expectation has both political and economic elements—particularly given the narrative of lower private final consumption vis à vis the overall GDP and the misery expressed by companies facing demand de-growth at the frontiers of the lower quintiles.
All economics is defined by politics. It is clear that sustaining growth and employment is paramount for the advanced economies as these nations enter the demographic dip. Higher growth in the US, for instance, is enabled by fiscal spend under the Inflation Reduction Act to subsidise onshoring of investment—the US can afford adding a trillion dollars to its debt every 100 days as the dollar enjoys exceptional privilege.
The worry in the advanced economies is about sustaining consumption. The concern for India and other developing economies will be to sustain investment. The strategy of the government to boost investment to crowd in private sector capex is riveted to public programmes.
India boosted overall public sector capital investment from Rs 5.6 lakh crore in 2014-15 to Rs 18.6 lakh crore in 2023-24 and this has had a visible impact on GDP growth. A report published by CRISIL shows that India will spend Rs 143 lakh crore on infrastructure between now and 2030—twice the Rs 67 lakh crore spent since 2017. It is true that robust tax collections—GST and direct taxes—have enabled the ramping up of investment in infrastructure.
It is equally evident that the cost of capital matters. The ambitious fiscal deficit target of 5.1 percent and the quest for a superior rating by global agencies demands a revival of ideas left dormant—from privatisation and asset monetisation to raising resources.
India has won accolades for the management of macro fundamentals. The context demands that the new government’s 100-day programme factors the spectre of higher-for-longer cost of capital and design a timeline for reducing deficit and retiring debt as it drafts the roadmap for Viksit Bharat.
Shankkar Aiyar
Author of The Gated Republic, Aadhaar: A Biometric History of India’s 12 Digit Revolution, and Accidental India
(shankkar.aiyar@gmail.com)