What India's Rate Cut Means for Global Stocks

Image courtesy David Castor via Wikimedia Commons.

Investors in the U.S. have gotten used to the idea that the next likely move from the Federal Reserve will be to move interest rates upward. Yet throughout most of the rest of the world, central banks are still looking to try to ease their monetary policy, and the question isn't whether rates will get cut but rather by how much. Overnight, the decision from the Reserve Bank of India to cut its key lending rate to commercial banks by half a percentage point to 6.75% showed just how aggressively many countries are taking the threat to their economic growth, and investors on the subcontinent reacted favorably, sending the BSE Sensex (NYSEINDEX: ^BSESN) up 162 points to 25,779 on a day in which most stock markets in the region suffered substantial declines.

What India thinks about the global economyThe Indian central bank gave a powerful rationale for its bigger-than-expected rate move. As it sees things, the bank argued that "global growth has moderated, especially in emerging market economies, global trade has deteriorated further, and downside risks to growth have increased." Although Europe has shown signs of recovery and U.S. consumer spending has helped offset recent declines in capital spending, Japan's economy continues to sputter, and emerging markets are suffering from capital outflows that are exacerbating economic challenges.

Meanwhile, in India, the Reserve Bank characterized conditions in mixed terms. It believes that "a tentative economic recovery is under way but is still far from robust," highlighting issues like a drier-than-normal monsoon season, headwinds for the export industry, and continuing declines in inflation. In addition, the central bank cited the Fed's decision not to raise interest rates as confirming its assessment of the global economy, with the clear intent that India wants to err on the side of caution to ensure a continuing growth trajectory.

Who will win: borrowers or banks?The key element for success in any central bank move is whether the rates it moves have a consequent effect on the broader economy. In most cases, banks act as a gateway through which a central bank's rate actions have to pass, and some investors are concerned that financial institutions might simply take the opportunity to widen their margins by keeping their lending rates constant while cutting their borrowing costs from the Reserve Bank.

Already, though, the Indian economy has held up well. The country recently surpassed China's growth rate, with projections for GDP to rise by more than 8% during the current fiscal year. Despite signs of sluggishness, the challenges that India has thus far faced pale in comparison to the bigger problems facing other major emerging markets like resource-rich Brazil and Russia.

Given its central bank's policy moves, India might well remain a bastion of strength in an environment of deteriorating confidence across the globe in the immediate future for stocks. The nation won't have a free ride to prosperity, but it has already taken tough steps in the right direction. That might not hold up the rest of the global stock market, but for those who see it as a safe haven, India might manage to escape the full extent of declines elsewhere.

The article What India's Rate Cut Means for Global Stocks originally appeared on Fool.com.

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