US Federal Reserves rate cut and its impact on India

• The US Federal Reserve has announced a quarter-percentage-point cut in interest rates — the first rate cut by the US central bank in 11 years.

Why is US Fed’s rate-cut significant?

• The cut in interest rates is the first time since the 2008 financial crisis.
• What is ironic is that this move comes despite a strong US economy and indicators such as job market data showing renewed buoyancy.
• The rate cut follows months of pressure from US President who has been pushing the American central bank for a cut in rates.

Impact on India

• A rate cut cycle means a weaker dollar, which is good for the US but may not be so for the rest of the world.
• It has been seen in the past that as the dollar weakens due to lower growth tendencies, the rupee has tended to strengthen which will pose a conundrum for us as exports will come under pressure.
• The exports will be reduced due to lower global growth and a stronger rupee. This will not be good for the current account deficit (CAD).

Benefits

• A rate cut in the US is good for emerging market economies and is projected to catalyse a debt and equity market rally in countries such as India.
• Typically, emerging economies such as India tend to have higher inflation and thereby higher interest rates than those in developed countries such as the US and Europe.
• As a result, investors would want to borrow money in the US at low-interest rates in dollar terms and then invest that money in bonds of emerging countries such as India in terms to earn a higher rate of interest.
• When the US Fed cuts its interest rates, the difference between interest rates of the two countries increases, thus making India more attractive for the currency carry trade.