U.S. Central Bank, the Fed, recently cut interest rates by 50 basis points, i.e., 0.5%. This is not unexpected, as there has been much discussion on how the Fed was going to cut rates by mid-late 2024.
Most other countries, because of the anticipation, have seen their exchange rates appreciate against the U.S. Dollar. The Indian Rupee appreciated 0.5% from $1 = ₹83.99, which was the target set by RBI, to $1 = ₹83.55 as of right now.
Other currencies have appreciated as well. Japanese Yen appreciated 10.6% since July, Indonesian Rupiah by 6.6%.
You might say this is good, so what’s the problem? The issue is that the high interest rates, contrary to mainstream narratives, have been stimulating the U.S. economy through increased interest payments on Government debt.
The interest payments themselves are giving free government money to the debt holders, increasing wealth inequality since the lower income percentiles are unable to save, while also having a stimulating effect on the economy. This is quite the opposite of the mainstream claim that higher interest rates result in less inflation.
What about the Indian Rupee?
In the short term, you will see an increase in stock prices and appreciation of the Indian Rupee. However, as the rate cuts result in reduced interest payments in the U.S., combined with insufficient government spending (fiscal policy), there will be a slowdown in the U.S. economy. This slowdown will then lead to lower demand for foreign goods in the U.S.
The issue is that the Indian economy is still highly dependent on global demand, particularly in trade. The LPG reforms have led India to pursue an export-oriented growth strategy. While a reduction in global demand could lead to lower oil prices, it would also result in decreased demand for Indian goods and services in the global market. This is the problem: if exports decline faster than imports, the end result would be a depreciation of the exchange rate.
Therefore, my suggestion remains the same as before. The RBI should stop wasting foreign exchange trying to maintain a target rate. Trade and capital controls must be tightened to boost domestic production and consumption, and government spending must be increased. However, none of this is likely to happen in reality, and the Indian economy is headed for a slowdown if the U.S. slows down.
That’s all.