The Federal Reserve meeting to decide on a base rate cut -- the 13th cut in a rate easing cycle which started in January 2001 -- is being closely watched by the Indian financial markets, both for clues on the long term outlook on interest rates as well as for whether the Reserve bank of India will cut the repo rate.
While the financial markets here have already factored in an 25 basis point cut in the Fed rate (from 1.25 per cent to 1 per cent), bond dealers look forward to the possibility of a 50 basis points, which might result in a runaway rally in the government securities market.
This, however, will not prompt the RBI to cut the repo rate as the Indian central bank is closely watching the inflation rate and the monsoon before announcing any cut in the short term repo rate.
A senior ICICI Bank treasury executive said that the market reaction is divided.
If the Fed cuts its rate by 50 basis points, it can definitely be concluded that the bias in favour of softer interest rates will continue for a longer period.
However, if a neutral policy is adopted on the rates, the longer term perspective on interest rates has to be reviewed.
Sudhir Joshi, treasurer, HDFC Bank, said: "The linkages of the globalised economy cannot be avoided. Therefore a rate cut by the Fed will necessarily put a downward pressure on interest rates in India."
On the other hand, S R Kamath, general manager, Securities Trading Corporation of India, feels that the rate cut will only provide a psychological effect with no likely immediate impact on bond yields.
"We tend to agree with the apex bank's stance that a repo rate cut is only possible with clear indications emerging on the monsoon and the rate of inflation scenario," he said.
Some market dealers think that even though a 25 basis points cut has been priced in, the actual cut will result in a temporary rally in the prices of government bonds.
With a 50 basis points cut, there will be a long term rally in the market, backed by a positive outlook on a soft interest rate policy.
This is because, irrespective of the fact that whether or not the repo rate is cut, interest rates will at least continue to remain soft in line with the global interest rates.
Foreign exchange dealers harbour the view that with huge flows coming into the Indian market, a wide disparity in domestic and overseas interest rates cannot be sustained for a long time.
"In order to bring down the arbitrage and resulting volatility arising out of the copious foreign exchange inflows, the Reserve Bank of India should look at cutting the repo rate to align domestic interest rates with the international scene and reduce arbitrage," said Manbir Bawa, senior foreign exchange analyst at Mecklai Financials.
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