The US Federal Reserve began its monetary policy easing cycle with an enormous 50 basis point (bps) interest rate drop in response to 'progress on inflation and the balance of risks'. The Fed Chair Jerome Powell-led Federal Open Market Committee (FOMC) cut the federal funds rate to 4.75% to 5%, citing inflation levels that were in line with its aim of 2% and a balanced labor market.
Despite the dramatic rate decrease, Powell highlighted that the economy is still in good shape and that 50 basis points will not be the pace of future easing. The dot plot is slightly more hawkish, with another 50 basis points cut by the end of CY2024 and an additional 100 basis points decrease in CY2025. One basis point equals one tenth of a percentage point.
This commencement of the easing cycle allows Emerging Market (EM) economies to kick-start their own. Following the US Federal Reserve's rate decrease, the Hong Kong Monetary Authority (HKMA) reduced its base rate charged through the overnight discount window by 50 basis points to 5.25%, while the Bank of Indonesia cut its rate by 25 basis points earlier in the day. According to the HKMA, the US interest rate drop will benefit the economy and allow for some local interest rate reductions.
Will the RBI follow suit?
Following the significant US Fed rate decrease, the Reserve Bank of India's (RBI) monetary policy meeting next month will be closely watched, with domestic retail inflation at 3.65% in August, maintaining within the central bank's tolerance zone of 2-6%.
Economists predict that, despite the fact that CPI inflation fell below the RBI's 4% objective, the RBI Governor Shaktikanta Das-led Monetary Policy Committee (MPC) would not lower interest rates immediately in October since the central bank will focus on domestic factors. Certain analysts anticipate a shift in policy stance with the impending RBI policy, although a repo rate drop is only likely in December.
Madhavi Arora, Lead Economist at Emkay Global Financial Services, feels that the Fed's large rate decrease has allowed EM Asia permission to continue with their own easing cycles, but she expects the RBI to lower interest rates for the first time in December.
"With the global market reaction being subdued thus far, the RBI still has the freedom to focus on domestic inflation and risk management. The RBI is likely to maintain its wait-and-see stance and focus on being 'actively disinflationary', with the first rate cut expected by December," highlighted Arora. According to her, the evidence for an early cut remains weak, and she expects small cuts from both the US Federal Reserve and the RBI this cycle.
On August 8, the RBI Governor-led MPC left the benchmark repo rate steady at 6.5% for the ninth consecutive meeting, retaining the policy stance of 'removal of accommodation'.
Purvi Mundhra, Economist at Systematix, anticipates the RBI to contemplate rate relaxation only in 2025; however, the amount would be determined by how the Credit-Deposit ratio drops in tandem with the inflation trend.
"We do not expect the RBI to instantly follow the Fed's rate-cutting cycle. Currently, the MPC decision is clouded by concerns about food inflation gaining core-type features and the loss of family savings, which are affecting the development prospects of banks that need to reduce the high Credit-Deposit ratio caused by high retail lending. Thus, implementing monetary easing would be incongruous at the moment," stated Mundhra.
A team of economists at Kotak Institutional Equities also believes that the RBI should be able to continue focusing on domestic factors and adjust its monetary stance at the next meeting.
"Comfortable domestic inflation and benign global conditions could help to shift the policy stance to 'Neutral' in October, especially as liquidity conditions have been permitted to remain comfortable. "We maintain our call for a shallow rate-cut cycle (75-100 basis points) beginning in December as inflation approaches 4% in FY2026," said Suvodeep Rakshit, Senior Economist at Kotak Institutional Equities.
Suman Chowdhury, Executive Director & Chief Economist, Acuité Ratings & Research, agreed that while the Reserve Bank of India is likely to take an independent view on any interest rate action in India, the Fed's strong rate cut may have increased the likelihood of a 25-bps cut from the MPC in December 2024, assuming no new surprises in food inflation.
On the contrary, Rishi Shah, Partner at Grant Thornton Bharat, feels that the likelihood of a repo rate drop in October has increased by a margin, given the FOMC's larger-than-expected cut. Overall, while the US Fed's aggressive 50 basis point rate decrease may create a precedent for emerging market economies, the RBI is anticipated to remain focused on local inflation and economic dynamics.
Economists expect that a rate drop will not occur until December 2024, with a small likelihood of a move in policy position in October. The cautious stance reflects worries about food inflation and family savings, making India's monetary policy more conservative despite the Fed's intervention.
