Opinion
The Federal Reserve's policy pivot poses a challenge for RBI
Summary
- A rate cut in the US could leave other central banks pressured to follow suit. RBI would hope inflation in India comes down fast, because unless the rupee’s internal value is fully under control, it may be able to focus on its external imbalance.
After much anticipation, the pivot in US monetary policy finally is taking place. On Friday, Federal Reserve chair Jerome Powell stated in no uncertain terms that “the time has come for policy to adjust," as US inflation—though still a little above its 2% policy goal—is seen firmly on a downtrend.
“The upside risks to inflation have diminished, and the downside risks to employment have increased," Powell said at the annual gathering of central bankers in Jackson Hole as he sought to explain the dovish turn.
What perhaps got the Fed worried is the bigger-than-expected rise in the unemployment rate in July and the subsequent jobs data revision that showed new jobs weren’t being created as hotly as previously thought. In such a situation, continuing with high rates for too long held out the risk of running the economy aground.
Having faced criticism for falling behind the curve in the aftermath of the pandemic when inflation was on the rise, the Fed, understandably, seems wary this time.
Also read: US Fed Chair Jackson Hole 2024 Highlights: Powell says ‘time has come’ for Fed to slash interest rates, stocks rally
As it is, it’s been facing increased heat from within to start cutting rates, with several members of the Federal Open Market Committee having favoured a reduction in the fed funds rate at its last meeting in July itself, according to the minutes released last week.
A September rate cut now looks certain, but the pace of cuts thereafter will depend on how the data unfolds. As borrowing costs fall, their stimulative effect should strengthen the US economy. Investors already seemed to cheer that prospect, with US stock markets rising modestly on Friday.
A broader whetting of risk appetite together with diminishing returns on US debt securities would also drive some money out of the world’s biggest economy and into emerging markets, including India. That said, central banks globally would feel pressure to move in step with the Fed so that a likely weakening of the dollar doesn’t hurt their exports.
A positive fallout, however, of a weaker dollar is for oil-importing countries. Since crude oil is priced in dollars, their import bills will decline. In the case of India, this could be substantial given we meet about four-fifths of our demand for oil through imports.
This should, in turn, help cool local inflation, both by directly lowering fuel prices and indirectly by pulling down transport costs for a swathe of goods.
Also read: Powell ignored the elephant in the Fed’s Jackson Hole lodge
Whether there would be enough of a drop—and soon—for the Reserve Bank of India (RBI) to lower its guard, though, is yet uncertain. Fortunately, rainfall has been plentiful this year, which should help cool food prices.
Notably, a couple of voices calling for rate cuts have already emerged in RBI’s monetary policy committee, but the remaining four members favoured a status quo at its most recent meeting.
A debate has also started over whether RBI should exclude food prices in calculating the inflation rate it targets after the government’s Economic Survey advocated such an exclusion given monetary policy has little influence on food prices. Much of their price swings in India are driven by supply factors.
But governor Shaktikanta Das has noted the role of food prices in feeding inflation expectations, which is why monetary policy can’t afford to go easy on them.
Also read: Powell’s Pivot Leaves Traders Debating Size, Path of Rate Cuts
That said, with the US policy shift posing a challenge for the rupee’s external value, RBI would hope price pressures cool quickly. Maintaining an ‘Arjun’s eye’ on the rupee’s internal value while ignoring its external imbalance just got tricky.
