8/7/2019 Cut in Fed Rate Affect Indian Economy

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US Fed Rate Cut: Will it Queer the pitch for some of the World’s fastest growingcountries like India.

The federal fund rate is reduced to 0.25% in Jan 2009 following the subprimecrises from the high of 5.25%in Sept 2007. Federal Fund rate is the rate thatbanks charge each other for overnight loans of federal funds, which are thereserves held by banks at the Fed. Federal Discount rate is the interest ratecharged to commercial banks and other depository institutions on loans theyreceive from their regional Federal Reserve Bank's lending facility.

The Subprime event in 2009 has forced the Federal Open Market Committee toreduce interest US Fed interest rate to 0.25%. The rate is maintained at thesame level currently. The Cut in interest rate is an indication the banks are morelikely to borrow which puts more reserves into the banking system. More moneysupply means banks can charge lower interest rates. There is a directrelationship with the discount rate and the overall level of interest rates. In otherwords, the direction of the changes is the same. For instance, if the Fed lowers

the discount rate, interest rates in general will fall.

With the current cut of Fed Interest rate, additional investment opportunities arediscouraged in United States. American Investors will look for alternativeinvestment opportunity in developing countries like India and China. This will ledto Foreign Institutional Investors inflows in developing countries. There is apositive impact on stock and forex market of developing countries due toincrease in liquidity by foreign institutional investors. With preferential liquidity inthe countries capital market, the market may reach new high, but the valuationsmay not be specific. In view of higher dollar return, American investors will infusedollar in the economy of developing countries, thereby strengthen local currencyand weakens dollar. Strong local currency will adversely affect the exporter asthe Indians goods will become costly to foreigners. This will discourage theforeigners to purchase and use Indian goods and commodity, thereby affectingthe export sales for Indian Companies. Export is critical to the growth of IndianEconomy. Major Industry to be affected includes IT Sector, Hotel Industry andother manufacturer whose revenue accounts for major share from United States.

The reduction is turnover of the company will be followed by fall in employmentrate and lower per capita income.

The bonds prices are inversely related to interest rate. With cut in federalinterest rate, the bonds prices will increase pushing the yield down. Thedeveloping country’s Central bank is expected to announce a series of measurelike open market operations, discount rate etc to ensure that excess liquidity inthe economy does not add to inflation. The Central bank will sell financial assetlike government bonds, foreign currency, or gold to curb the excess money incirculation.

By: Namrata Shah

8/7/2019 Cut in Fed Rate Affect Indian Economy

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US Fed Rate Cut: Will it Queer the pitch for some of the World’s fastest growingcountries like India.

Later on heavy foreign exchange outflows in the wake of sustained selling by FIIson the bourses and withdrawal of funds will put additional pressure on dollardemand.

Strong local currency will benefit importer as the imports will be cheaper. MajorIndustry to benefit include Oil companies, electronic goods etc. Also, strong localcurrency gives the Indian companies better bargaining power at time of foreignacquisition. However, in cases where huge foreign investment is in form of setting up plant in the country, then the developing country will be benefitedwith fall in unemployment rate and rise in per capita income. Strong localcurrency will also be beneficial for companies whose major revenue share is indomestic currency. Such companies can borrow cheaper foreign debt andexpand their capex to capture additional market share.

The Cut in Fed rate will affect companies in different sector in different ways.

By: Namrata Shah