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Since the onset of the COVID-19, the US Federal Bank has taken significant steps to manage the economy. As the inflation concerns grew in 2022-23 the Fed rates grew aggressively to combat the rising prices, this was done to cool down inflation, set a clear trajectory for global central banks, including RBI, which also raised its rates in tandem with the Fed.
The RBI has mostly followed the Fed’s actions in adjusting its monetary policy.
In 2023, when the Fed increased rates by 0.25%, the RBI soon followed, raising its rates from 6.25 to 6.50 in February 2023.
On 19-09-2024 the 10-year Indian Government Bond increased by 1.33% (daily basis) to 6.87%. This was a reaction to the US Fed Bank decreasing the interest rate by 0.50 bps (base points) on 18-09-2024.
This resulted in the flow of funds of the Foreign Institutional Investors from India to the US. This rate cut was done to control the inflation rate.
The relationship between the price of the bond and the bond yield is inverse. If the bond yield increases the price of the bond decreases and if the yield decreases the bond price increases.
For instance, if the 5% 1 Year Indian Government of face value Rs100 rises to Rs 150 the bond yield comes down to 33.34% and if the price goes down to Rs 80, the yield increases to 6.25%.
The Indian Stock market reacted aggressively positive to this rate. The Bank Nifty grew by around 2% from 52,929.25 to 53,793.20 marking an All-time high. Even Nasdaq grew by almost 2.50% in reaction to the rate cut.
All the Indian investors’ eyes are on the Reserve Bank of India now. The RBI is expected to reduce the repo rates to control/reduce the inflation in India.
The typical reason for changing the rates of borrowing is to control the flow of funds in the economy.
The rates are increased during inflation to make the borrowings expensive, which reduces the investment in the economy. And the rates are cut during recession period to make the borrowing cheaper and hence encourages the investors to pump funds into the economy.
The RBI last changed the repo rate from 6.25% to 6.50% on 08-02-2023 which was in reaction to the change in interest rate by the US Federal Bank on 01-02-2023 from 4.50 to 4.75%.
On 26-07-2024 the US Federal Bank cut the rate from 5.50% to 5.25%. Whereas the RBI kept the rates unchanged, which resulted in a huge sell-off from FIIs.
Due to a 0.50% rate cut by Fed Bank, the RBI is expected to make a change in the upcoming meeting in October-November as to keep the foreign investors’ money in India only.
Below is the comparative chart for the rates of both RBI and Federal Bank.
Thank you.
Regards,
Kautilya, IBS Mumbai.
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