Since 2020, the Federal Reserve has raised interest rates by more than 4.50% on 11 occasions. Meanwhile, the Reserve Bank of India has raised interest rates by 1.10% on 5 occasions.
On September 18, the US Federal Reserve cut interest rates after four years. The 50 basis point (0.5%) cut is more than the experts' expectations. Now interest rates will remain between 4.75% and 5.25%. America is the world's largest economy, so every major decision of its central bank affects economies around the world.
Impact of the cut: Interest rates may come down in India too, loans will be cheaper
- After the reduction in interest rates in the US, the Reserve Bank of India may also reduce the rate. This reduction may put pressure on the banking sector. As interest rates fall, bank deposits become less attractive to customers. This will affect banking profitability in the medium term. However, the real estate sector may benefit from low loan rates.
- The rate cut has increased the difference between the interest rates of the US and other countries. This will increase the currency carry trade (taking a low-interest loan and investing it in the high-interest market and earning money from it) in countries like India. In such a situation, the lower the interest rate in the US, the greater the arbitrage opportunity. Arbitrage opportunity is a situation where people earn money by taking advantage of the difference in prices in the markets.
- A lower US rate can boost foreign investment in India, which will strengthen the currency and equity markets. Its effect has also been seen on the US and Indian markets. On September 19, the US market's Dow Jones closed at 42,025, up 1.26%. Today, on September 20, the Sensex made a high of 84,694 and the Nifty made a high of 25,849.
- Rate cuts often lead to a depreciation of the US dollar, affecting global trade balances and exchange rates. A weaker dollar can lead to higher prices of commodities such as oil and gold, as these are usually priced in dollars. Gold in India today rose by ₹220 to ₹73,202. Silver was selling at ₹88,612 per kg.
Since 2020, the Federal Reserve has raised interest rates by more than 4.50% 11 times
Since March 2020, the US Central Bank has reduced interest rates thrice, in which the maximum rate cut was 1.5% in two times during the Corona epidemic. However, after that, in the next 11 meetings, the Fed increased the interest rates by more than 4.50%. This is more than the pre-Covid period i.e. March 2020 level. Till October 2019, Fed rates were between 1.50% and 1.75%.
Since 2020, the Reserve Bank of India has raised interest rates by 1.10% in 5 times
At the same time, the Reserve Bank of India (RBI) cut interest rates by 0.40% twice during Corona (27 March 2020 to 9 October 2020). After this, in the next 10 meetings, the Central Bank increased interest rates 5 times, did not change it four times and once cut it by 0.50% in August 2022. Before Covid, the repo rate was at 5.15% on 6 February 2020.
India may see a reduction of 0.25% by March 2025
- Dr. VK Vijayakumar, Chief Investment Strategist, Geojit Financial Services, said that India may see a reduction of 0.25% by March 2025. RBI has not changed the interest rates since 8 February 2023. Currently the repo rate is 6.50%.
- Vijay Bharadiya, Founder, Wallfort Financial Services Ltd, said the rate cut is a bold move that could encourage other global central banks, including the Reserve Bank of India (RBI), to adopt a softer monetary stance.
Policy rate is a powerful tool to fight inflation
Any central bank has a powerful tool to fight inflation in the form of the policy rate. When inflation is too high, the central bank tries to reduce the money flow in the economy by increasing the policy rate.
If the policy rate is high, the loan that banks get from the central bank will be expensive. In return, banks make loans expensive for their customers. This reduces the money flow in the economy. When the money flow decreases, demand decreases and inflation decreases.
Similarly, when the economy goes through a bad phase, there is a need to increase the money flow for recovery. In such a situation, the central bank reduces the policy rate. This makes the loan that banks get from the central bank cheaper and customers also get loans at a cheaper rate.
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