Major US rate cut: What will India do?
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Today on The Daily Brief:
First time in 4 years
India’s trade deficit
First time in 4 years
In yesterday’s edition, we covered about the possibility of the US Federal Reserve cutting interest rates and why it’s important not just for the US but also for economies worldwide, including India. Well, as expected, the Fed made its move. For the first time in four years, they cut rates by 0.5 percentage points.
The Fed is doing this because the US job market is slowing down, inflation is cooling off, and they want to keep the economy stable. Fed Chairman Jerome Powell said, "The US economy is in a good place, and our decision today is designed to keep it there."
But that’s the US—what does this mean for us in India?
Here’s the thing: when the Fed makes a move like this, it has a ripple effect. The US dollar is a major player globally, so anything that affects its value impacts everyone else, including us. In India, the Reserve Bank of India (RBI) often looks at what the Fed does before adjusting our interest rates, like we discussed yesterday. But that doesn’t mean the RBI will always follow immediately; they have their own considerations, and it’s important for us as investors to understand why.
Here’s what could happen if the RBI doesn’t follow the Fed’s lead:
Cheaper imports: If the RBI keeps interest rates high while the Fed lowers theirs, the rupee could get stronger against the dollar. A stronger rupee means imports like oil, electronics, and machinery become cheaper. While that sounds great, there’s a downside—cheaper imports can lead us to buy more from abroad, which can put pressure on our foreign exchange reserves.
Expensive exports: A stronger rupee also makes Indian goods pricier in global markets. This is tough for exporters because when our goods are more expensive, demand drops. This can impact jobs in export-heavy sectors like textiles, agriculture, and IT services, which are crucial for employment, especially in rural and semi-urban areas.
The RBI’s main job is to keep inflation in check. They do care about the rupee, but their priority is to make sure prices don’t get out of control. Right now, overall inflation is within the RBI’s target range of 2-6%, but food prices are still a concern.
Because of this, the RBI might hold off on cutting rates for now. SBI Chairman C.S. Setty also echoed this, saying, “While the Fed rate cut would influence everyone, the RBI would be mindful of food inflation before deciding on interest rate cuts.”
So, in short, the RBI has a tough call to make. The Fed’s rate cut will definitely create ripples, but the RBI has to consider a lot—like inflation, the rupee’s value, and the state of our exports—before making a move. At the end of the day, it’s all about finding the right balance. The RBI’s next steps in the coming months will shape India’s economy, so it’ll be interesting to see what happens next.
India’s trade deficit
India’s trade deficit, which is the gap between what we import and export, recently widened to its highest level in ten months! In August 2024, this deficit hit around $30 billion, mainly because of a surge in gold imports and a drop in exports. For some context, economists expected the deficit to be around $23 billion, so $30 billion is about one-third higher than predicted.
At first glance, this might sound pretty alarming. But it's not as bad as it seems. Let me explain why.
The trade deficit we’re talking about here is specifically the merchandise trade deficit, which only covers physical goods and doesn’t include services. If we factor in services, where India has a $15 billion surplus, the overall trade picture looks much better.
Still, there’s something interesting going on here that’s worth understanding, especially from an investor’s point of view. Let’s break down why gold imports have jumped, why exports are falling, and how the global economy is affecting India’s trade situation. I’ll also touch on what this deficit means for India’s economic strategy and what could be done about it.
Why is the merchandise deficit growing?
Rise in Gold Imports: The biggest factor driving the deficit is gold. Gold imports shot up to over $10 billion, which is three times the monthly average earlier this year. This spike happened because of a recent cut in import duties on gold from 15% to 6%. Plus, with the festive season coming up, traders are stocking up on gold while prices are low. The good news is that if August saw a big surge in gold imports, they might level off in the coming months.
China’s Economic Slowdown: China’s economy is struggling, which means its domestic consumption has slowed down a lot. As a result, China is exporting more goods at very low prices, flooding global markets. These cheap Chinese goods make it tough for Indian manufacturers to compete, putting pressure on our exports.
Global Supply Chain Disruptions: Disruptions in global supply chains have pushed up freight costs, especially because of problems around the Red Sea and the Suez Canal. Normally, this route is a shortcut between Asia, Europe, and the US. But with these disruptions, ships are taking longer routes around Africa, which adds time and costs, affecting Indian exporters.
How can this be addressed?
These issues are complex, but there are a few ways that could help:
Boost Domestic Production: The best long-term solution to tackle the trade deficit is to strengthen domestic manufacturing. The government has been pushing initiatives like Make in India and the Production Linked Incentive (PLI) scheme and investing heavily in logistics. If the deficit persists, it might be time to rethink our approach to manufacturing and trade policies more broadly.
Leverage Our Services Surplus: India’s strength in services, especially with our Global Capacity Centres, can help balance out our merchandise deficits. Increasing service exports is a great way to bring more money into the country and manage the overall trade balance better.
Attract More Foreign Investment: Another way to boost our balance of payments is by attracting more foreign investment. Although many countries are looking for alternatives to China, foreign investment into India has been falling. Drawing more of this investment can provide immediate benefits to our economy and strengthen our manufacturing ecosystem in the long run.
To conclude, while news of India’s widening trade deficit might sound concerning, it’s crucial to keep the bigger picture in mind. Our strong foreign reserves, which are at their highest levels ever, also provide a buffer against short-term shocks. So, while the numbers might look worrying, we have the tools and potential to navigate through this challenge.
That said, the key to long-term stability lies in improving India’s overall trade economy. The last severe balance of payments crisis we faced was back in the 1990s, and the solution then was to open up and liberalize the economy. While the current situation isn’t as severe, there might still be some valuable lessons we can learn from that experience.
Tidbits:
India has approved ₹20,193 crore for ISRO’s space projects, including the Gaganyaan human spaceflight, a new moon mission, and a mission to Venus. This funding will help drive research and boost private sector involvement in space.
Zee Entertainment is in a legal battle with Star India over a $1.4 billion cricket broadcasting deal that Zee pulled out of. Star India is seeking $940 million in damages.
Alibaba has launched over 100 new AI models to compete with companies like Baidu and Microsoft. They’ve also introduced a tool that allows users to create videos just by typing a simple prompt.
Binance accused WazirX and its founder of misleading customers about their relationship after a $230 million hack. Binance stated it never owned or controlled WazirX and called on WazirX’s parent company to compensate users.
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