What happens to the Indian economy and stocks when the Fed cuts rates?

This report is from this week’s CNBC’s “Inside India” newsletter which brings you timely, insightful news and market commentary on the emerging powerhouse and the big businesses behind its meteoric rise. Like what you see? You can subscribe here.

The Federal Reserve is almost certain to start its rate-cutting cycle next week.

Historically, a rate cut has been a signal for central banks in emerging markets, like India, to follow by easing monetary policy in their regions.

However, this time, it’s likely to be different.

When will India cut rates?

The latest data shows that the inflation rate appears to be heading in the wrong direction in India. The headline inflation rate rose in August to 3.65% compared to 3.6% in the previous month. Food prices, which constitute a large proportion of overall inflation, appeared to be one of the big drivers.

Is it a cause for alarm? Not really, since the latest figures are still below the Indian central bank’s target of 4%. Instead, markets have simply hit snooze on a rate cut by the Reserve Bank of India for the moment.

“The slight rise in India’s headline CPI inflation in August reinforces our view that the Reserve Bank will proceed with a bit of caution and keep rates unchanged in its next meeting in October,” Shilan Shah, deputy chief emerging markets economist at Capital Economics, told clients. “But it won’t wait until any later than December to begin loosening policy.”

But as Inside India covered last week, India’s GDP slowed to 6.7% in the second calendar quarter compared to last year’s 8.2%, piling pressure on the central bank to take its foot off the brakes sooner rather than later.

A rate cut by the Fed is also widely expected to provide more immediate relief to the Indian rupee, which fell to an all-time low against the greenback last week. Cutting ahead of the Federal Reserve or alongside it, would have risked pushing the rupee lower, further adding to inflationary pressures.

“Interest rates across the world have seen a sharp jump and a cycle reversal seems likely in the coming quarters which would create headroom for the RBI to also taper down benchmark interest rates in India,” said Mahesh Nandurkar, head of India research at Jefferies, in a note to clients.

Bank of America also sees rate cuts beginning in December 2024, with interest rates in India lower by an entire percentage point by the end of next year.

How will stocks react?

If there’s no global recession, a risk-on sentiment will likely help push up emerging market equities in the medium term after the U.S. central bank cuts rates. However, the path stocks take is unlikely to be in a straight line.

“According to our colleagues, global equities typically fare well around rate cuts and are on average higher 12 [months] after the start of the easing cycles unless there is significant recessions/crises,” said Surendra Goyal, head of India research at Citi, in a note to clients.

However, the premier benchmark index of the Indian stock…