How Do Federal Reserve Rate Cuts Impact India?
Fed Chair Jerome Powell at Jackson Hole, 2024
At the Jackson Hole Economic Symposium last week (Aug 22 to Aug 24) in Jackson Hole, Wyoming, the world’s top journalists, economists, and central bankers met to share research and align strategies. Powell strongly indicated the U.S. will cut rates from their 23-year high in September. As central banks worldwide, including the European Central Bank's Governing Council, the Bank of Canada, and the Bank of England, begin to signal the end of their high-interest-rate policies, the global economy is transitioning away from the aggressive measures used to combat post-pandemic inflation. Markets are pricing in a 61 percent chance of a 25 bps cut in the Federal Reserve target interest rate in September, and a 39 percent chance of a 50 bps cut.
Federal Reserve rate cuts typically free up capital seeking higher return opportunities elsewhere, often in the U.S. equities market and abroad, often a positive for emerging markets. Here are a few potential impacts on Indian markets:
RBI has more room to cut rates: Since U.S. financial markets and the dollar are deeply entrenched in global markets, central bankers often wait for the Federal Reserve’s forward guidance before solidifying their strategies in order to avoid divergences. Because the Federal Reserve has kept interest rates high since July 2023, the Reserve Bank of India has limited flexibility to lower rates without risking a depreciation of the rupee against the U.S. dollar. Such a move could make imports more expensive for Indians and prompt investors to abandon the rupee in favor of higher-yielding currencies. Now, the RBI has more room to cut rates (for the first time in 4 years) from the 6.5 percent benchmark, though RBI Governor Das has indicated he will wait for food and core inflation to cool off further. Retail inflation is now at 3.54%, within the 4% target band. Food inflation continues to drive the inflation rate up, but Governor Das signaled that the board expects food inflation to taper off with growing monsoons.
Loan volume will likely increase: The National Bureau of Research found that between 1980 to 2015, a 4 percentage point cut in Federal Reserve rates was met with a 32 percent increase in loan volumes in emerging markets. This is because banks skew to riskier assets as the spread between the Fed target interest rate and the 10-year Treasury yield narrows. Consumer loans are already skyrocketing in India, with personal and retail loans growing at double-digit rates through 2023 and 2024, and security issuance rising to an all-time high of $11.9 billion. RBI has stepped in to limit the risk of faulty loan formations, which will cut loan growth expectations; for example, in May 2024, it asked all non-banking financial companies to cap personal loans to $240 a month.
Indian equities could see stronger fundamentals: While growth stocks would benefit the most, other export-driven industries like automobiles, industrials, and IT could benefit from growing sales and a weakening dollar. A strengthening rupee would lead to greater profits when converting revenue back and a weaker dollar would increase exports to parts of Asia and Europe. Additionally, company import costs would fall as the rupee strengthened relative to the dollar. Investors seeking higher returns can be expected to move capital to India, which will increase FII flows that have been relatively slow this year. RBI rate cuts would further bolster the domestic equities market. The Nifty50 and BSE Sensex both rose last Friday after Powell’s speech indicating rate cuts.
