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The Fed acts as the world central bank and its policy directions feed global economic charts and its monetary policies reverberate across worldwide financial markets. The most effective levers which the Fed employs to control growth of the economy include the federal funds rate which is a well-known interest rate. This is not a local activity since the Federal Funds rates directly impacts global financial systems and economies whenever is reduces the rate. However in this article, we will see the effects that have emanated from the Fed’s rate cut on India’s financial markets, and globally.

Understanding the Fed’s Interest Rate Decision

The Federal Reserve is a central bank of the United States that is responsible for making decision on the monetary policy in the country. It has one of its goals on maintaining economic sustainability by setting up measures that moderate inflation, promote maximum levels of employment and cost of borrowing which subsequently influences levels of economic growth.

Federal funds rate that is the interest rate for U.S. commercial bank’s lending of reserve balances to other depository institutions for immediate needs. When the Fed lowers this rate, borrowing is cheaper and businesses as well as consumers will borrow in order to increase spending hence stimulating the economy. It is also expressed in a period of economic growth and used to increase the rate of growth by reducing interest rate.

The effect of this decision does not abruptly stop at the American economy’s doorsteps – the whole world is affected. People around the world including the Indian economy and financial markets are affected by US monetary policy. Now, let’s understand how these shifts impact India and the global economy.

Impact on India’s Financial Markets

1.Capital Flows and Foreign Investments

The first effect of any adjustment made by the Fed rate on India is the flow of capital. When interest rates are lowered in US then investor looks for better return elsewhere to invest and emerging economy like India becomes favourable for foreign investment. This brings in fresh foreign exchange that could be channeled in equities, bonds and other financial securities; thus have a positive impact for the Indian stock market. Since the rate cut means borrowing is cheaper in the U.S.

investing in India becomes more attractive especially since the Indian stock market yields more than the developed markets. This trend helps the increase of the investors’ confidence, the growth of stock market value, and the strengthening of the Indian Rupee. Jog (2009) summarises that India can experience an increment of foreign direct investments (FDI) and foreign institutional investments (FII).

2. Interest Rates in India

The melee arising from the reduction in rates by the Fed impacts, in equal measure, Indian interest rates.Even though the RBI has its own autonomy in determining its monetary policy it can be moved by the Fed rates cut decisions.That means lower global interest rates pull down our interest rates, especially if inflation is well contained, implying that the global environment pressurises the RBI to lower rates.

This is so because when the differential with India grows higher than the U.S therefore reducing foreign investment and being a threat to the exchange rate.If the RBI copy the Fed in this aspect and reduces the rates that the Indian borrowers have to pay then consumers as well as businesses will get a chance to borrow at comparatively lower rates.This could have positive impacts on industries such as real estate, infrastructure and manufacturing which will help augment the growth rate of the country.On the other hand, if RBI failed to implemented rate cut then you may find a stronger rupee that poses threat to export of Indian exports.

3.Stock Market Volatility

Along with generating short-term market enthusiasm, the action, unfortunately, increases volatility. This is usually the case particularly among the foreign institutional investors (FIIs). In other words, if the rate cut response to hopelessly poor data, then people may start to worry about global growth, which will cause fluctuations in stock markets.

But if the cut is interpreted as a positive sign for a recovery, the Indian stocks can move quite a lot up. Normally, industries such as banking and real estate and infrastructure sectors are the gainer through lower interest rate while competitive export industries such as IT & pharmaceutical suffer due to volatility in currency.

4. Currency Market Impact

The rate cut which was implemented by the Fed can as well affect the value of the Indian Rupee (INR). When a rate reduction is made in the United States it make the green back to reduce in value against other currencies such as the Indian rupee. When the dollar is fairly frail, the rupee may get a boost and Indian products seem far less attractive in the international market.

Indian Rupee is a bit fluctuating currency,.where is a bane for importers ,dependent on imported, equipment machinery, essentials,spare etc.But of strong point for exporters selling their products in global market. On one hand it lowers the cost of imports, through promoting the gains from trade consumers and importing firms stand to gain. On the same note, it increases the cost of Indian products in foreign markets thus causing demand pull back for its exports.

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5.Inflationary Pressures

With global interest rates down, pressures such inflation may build up in emerging economies such as India. When the rate is lowered, the interest on loans decrease which help boost demand in the economy but that pressure the prices in the market. If the inflation rate in India goes up and breach the target provided by the RBI, thereby making appropriate measure be called on in other to avoid the economy from overheating.

As with most aspects, thereby the management of economic growth and inflation presents some challenge where, when the available levers are pulled in one direction, a number of other factors and potential issues might be pulled along with it. Thus, although rate cut is useful to some sectors, it has diverse risks since an increase in inflation leads to policy reversal by the RBI.

Global Economic Implications

1. Impact on Global Trade

Global trade is likely to be promoted as a Fed rate cut reduces the cost of capital for such companies across the globe. As the cost of borrowing rises abroad, it means that the American companies are more inclined to fund expansion of operations, new projects as well as increasing production. Which in turn increases consumption demand of goods and services of other nation’s such as India. On the flip side, a weaker dollar, due to rate cut might make imports costly for those countries, whose currencies toted to dollar. This could spur a behaviour that propels global commodity prices that harms countries that heavily rely on importation of oil, metals and other commodities.

2. Developed vs. Emerging Market Economies

In effect, a Fed rate cut means quite a different thing to a developed economy in contrast to what it is to an emerging economy. While definitely, European or Japanese economy can gain from cheaper pricing of credit risks, Indian economy is more vulnerable to capital mobility and its fluctuations. When the U.S. reduces its interest rate, money is channeled to emerging markets in an endeavor to get higher returns buoying stock markets, and bond yields. But, if the rate cut signifies global economic slowdown, then it can trigger capital flight in the emergent markets and financial volatility magnifying through depreciation of the currencies.

3. Commodity Prices and Inflation

Hypothesis One test reveals that commodity markets are highly sensitive to US monetary policy conditions. Thus, when the Fed cuts its rates, it depresses the dollar making gold, oil, and agricultural product more expensive. Thus, for countries such as India, which are on the consumers’ side, fluctuating crude oil price may turn into a problem. For instance, a hike in the prices of oil boosts the cost of transportation hence puts pressure on inflation. At the same time, it may also put pressure on other central banks to respond in kind this could neutralise the intended benefits of the Fed’s rate cut.

4. Global Debt Markets

They also affect the global debt market in a big way mainly through the Fed rate cuts. Normally, low interest rates in the seven countries including the U.S result in low yields on bonds, this causes investors to seek other better options in other countries. This may result in an increased demand for government and corporate bonds in emerging markets; India included, propping up the borrowing costs of businesses and government. But, if the rate f US dollar remain low for a long period then this leads to more borrowings in the world which are may resulting in sovereign and corporate loan concern specially in emergence market.

Conclusion

This decision has ripple effect that reaches beyond the United States economy right to the Indian economy and the world at large. More visible, are the impact on capital flows, interest rates and stock market volatility in the short run and inflation pressures, exchange rate movements and the growth trend in the long run.

For the whole world economy, rate change in America aids in exports and importation, alters production of commodities and even shapes the global credit markets. However, it also has its drawbacks which can be observed in the increased oil prices, especially by the newcomers on the oil market, which often have to closely regulate the influx of capital to their economy.

Therefore, though falling rates from the Fed might be on the positive side at least in the interim, it is important that the Indian economy and the wider global financial market monitor and in the worst-case scenario rebalance when necessary. Depending on the manner in which countries, businesses and markets adapt to change precipitated by this instrumental global monetary policy decision, the effects can be either positive or negative.

Source : Buzz Artical & HSUX Solutions

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