Pivot to watch: on the U.S. Fed’s rate reduction, its impact

The U.S. Federal Reserve on Wednesday cut interest rates for the first time in more than four years, lowering its benchmark interest rate by half a percentage point, in a policy pivot that is bound to have far reaching implications. Elaborating on the rationale for the cut after having raised the federal funds rate to its highest level in about two decades and held it there for more than a year, Fed Chairman Jerome Powell said, “… with an appropriate recalibration of our policy stance, strength in the labour market can be maintained in a context of moderate growth and inflation moving sustainably down to 2%”. Policymakers of the Federal Open Market Committee (FOMC) also signalled by a 17 to 2 majority that they expect at least another quarter point reduction in 2024. The Fed, which has a dual mandate of ensuring maximum employment even as it seeks to keep inflation at 2% over the longer run, had been raising rates since early 2022 when a COVID-19 pandemic-driven surge in prices had forced it to focus largely on taming inflation. Given that the U.S. central bank’s unrelenting rate increases and subsequent decision to hold the rate at an elevated level had rippled through the global economy, particularly as it led to the dollar strengthening against most currencies of emerging market economies (EMEs), the latest pivot will bring relief. As the Reserve Bank of India Governor Shaktikanta Das has noted, “a strong U.S. dollar increases debt service burdens and inflationary pressures for EMEs”.

India’s Chief Economic Adviser V. Anantha Nageswaran welcomed the rate move but stressed that the Fed’s rate reduction would ‘on the margins have a limited impact’ given that investor interest in the country’s economy had already been fairly significant over the last several years. However, like a recent blog post by two IMF economists posits, “The onset of a Fed easing cycle may support… a broader revival of capital flows to emerging market and developing economies.” India too is very likely to see an increase in foreign portfolio investor inflows, especially into its debt markets. The relief though is certain to be far more palpable for other emerging and developing economies in Africa and Latin America, where the high costs of servicing overseas borrowings had severely impaired those countries’ ability to invest in vital public infrastructure and services. And while Mr. Powell repeatedly emphasised that the world’s largest economy was overall “strong”, the uncertainties clouding the global economic outlook, including the volatile conflicts in Europe and West Asia mean that the Fed’s pivot also runs the risk of being read as a cautionary signal of troubled times ahead.