2024-09-25 14:29:30
Neelkanth Mishra
The US central bank Federal Reserve (RBI is the same institution in India) last week kicked off a long-awaited cycle of interest rate cuts. It reduced interest rates by half a percentage point.Why rates decreased: Why did the monetary policy change in America? The Federal Reserve has two responsibilities. First, maximum employment conditions should be maintained. Second, inflation rate should remain within a limit. The Federal Reserve said that the risk regarding both the responsibilities is almost balanced. Inflation is decreasing, but employment is decreasing.
Inflation will decrease further: The world’s stock markets also keep an eye on the Federal Reserve. The market decides its course by looking at how the economic estimates presented by its committee members differ from their previous estimates. So this time, the estimates presented by these members say that the inflation rate for 2024 and 2025 will remain below the current level.
Unemployment will increase: On the other hand, the unemployment rate is expected to increase at the end of this year and next year. In 2024, they have projected the unemployment rate to be 4.4%, while there is a fear of it being above ‘normal’ for next year as well. Right now it is close to 4.2%. Therefore, there is a possibility of further reduction in interest rates in the remaining months of this year and next year.
Market Reaction: Financial markets often predict the future and move accordingly. The Federal Reserve’s reduction in interest rates last week was already anticipated. Therefore, after this move by the Federal Reserve, US bond yields went up, whereas they should have come down. On the other hand, the stock market was expected to rise, but it closed with a slight decline.
Hope on Growth: We believe that the Fed’s forecast of low inflation and stable growth is called the ‘Goldilocks’ situation, that is, the economy is balanced and the target of reducing inflation rate can be achieved without affecting growth. The US central bank has maintained its forecast of 2% GDP growth in 2024, 2025 and 2026, which seems overly optimistic.
Government support: Last year, the US economy grew at a good pace, but it was supported by increased government spending. This is why the US fiscal deficit increased. Therefore, the Federal Reserve had difficulty in reducing inflation by higher interest rates.
Pressure on growth: We believe that the recent slowdown in US growth will continue. This will further increase unemployment. This will increase America’s challenges in terms of fiscal balance. In these circumstances, the question will also remain as to how much interest rates can be reduced in America while avoiding recession.
Loans are not very cheap: The Federal Reserve has indicated that it will cut interest rates by 2% over the next two years, but we believe that the rate at which people and businesses get loans will not fall much from current levels. This is because these rates are determined by the yield on long-term government bonds and are not expected to fall much from current levels without a recession. The reason for the high debt and GDP ratio of the US government may be the reason for the bond yield to remain high.
Impact on the world: Central banks of many countries like China and Europe have cut interest rates. The reason for this is that the dollar dominates the global financial market and the end of monetary tightening in the US has started a change in financial conditions at the international level.
Impact on India: Now let us see what effect this change in America will have on the Indian market? There has been some slowdown in the Indian economy in the last few months. There are three reasons for this. First, due to the elections, there was no increase in expenditure by the central and state governments. Second, there has been a big decline in the growth of money supply in the economy. Third, the export sector has been badly affected due to the weakening of global demand and China.
The solution will be like this: With time, the first problem will be solved by increasing government expenditure. Initial signs of this have also started appearing. The second problem was due to the fear that the increase in money supply could increase currency fluctuations due to speculation. But for more than two months, the Reserve Bank has maintained a surplus overnight money supply. With this, it has also given a message of a changed attitude regarding the future.
Rates will decrease here too: There are no indications of a reduction in rates from the Indian financial market yet, but after the Federal Reserve cut rates, there may be an opportunity for the Reserve Bank to take further steps in this regard. This should support the stock market. Also, now domestic investors are investing a lot of money, so the valuation of the Indian market may also remain high.
(The author is Chief Economist, Axis Bank)