Why the Central Bank of the USA has cut interest rates after almost four years and what it means for the Indian Economy.

The story

The US Federal Reserve (or US Fed as they call it), on 18th September, cut interest rates for the first time since March 2020.

While the move was expected, the debate was over the extent it would do 25 or 50 basis points. It turned out to be 50 basis points, or 0.5%.

For context, this is only the third time in the US Fed’s history that the central bank has started a rate-cutting cycle with a 50 basis point reduction.

And as the saying goes, “When the US sneezes, the world catches a cold.” So this rate cut would probably affect India too.

Let’s break down what it means and how it affects us.

What does it mean?

When the economic growth of a country is slowing down, as it is happening in the USA, it needs a push to regain the pace.

How could you possibly do it? The answer is by cutting interest rates.

Imagine it like this: low interest rates encourage people to borrow more, making big purchases, such as houses and automobiles, more affordable. Businesses also ramp up their capital expenditure, taking the advantage of affordable loans.

So the spending increases, demand picks up, companies increase their production and begin hiring more people to cater to higher demand, and ultimately the economy churns.

So the rate cut is a mechanism available to central banks to steer economic growth and the money supply through a ripple effect.

And it affects different sectors of the economy on various scales. For example, capital-intensive sectors, such as real estate, are more sensitive to interest rates.

That’s the long and short of it. Now let’s see how it could affect us.

How does it affect India?

1. More liquidity in Indian markets

With Indian bonds offering higher interest rates, they become more attractive to investors. More investment flows in, giving a boost to the economy.

2. INR becomes stronger
As investments flow into India, demand for the INR rises, strengthening it against the USD. It’s positive for importers and could be negative for exporters.

3. Gold shines brighter
A low interest rate means more money circulating in the economy, which devalues the currency. To hedge their USD-denominated investments, investors purchase gold, which increases the demand for gold.

To conclude

All in all, it is a positive development for a country like India as we emerge as an attractive destination for investments.

Every central bank, including The Reserve Bank of India (RBI), keeps monitoring the US Fed’s actions as it has a ripple effect in India too. When the US Fed cuts or raises rates, other central banks often follow suit.

Will the RBI too, start the rate-cutting cycle? Only time will tell.