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.

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 exchange, Nifty 50, is likely to be the one exception to the rule, according to Bank of America.

“While the Fed cuts rates, that could possibly lead to RBI cutting rates as well, and that is negative for earnings in the banking sector, which is a large weight in the index which we have,” Amish Shah, BofA’s Head of India Research told CNBC’s “Squawk Box Europe” on Wednesday.

Bank profits are typically cyclical and depend on the interest rate levels.

A fall in base rates will likely squeeze margins at most banks, prompting BofA to be “cautious” about the Nifty 50’s prospects over the near term. Banks have the largest weight in the index and make up nearly a fifth of the 50 stocks.

“Our view is that large cap stocks aren’t very expensive and therefore, markets could probably go sideways for some time,” Shah added.

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India’s rural demand will outpace urban consumption in the near term. That’s according to Upasana Chachra, chief India economist at Morgan Stanley. Chachra notes that sales of fast-moving consumer goods are rising in rural areas. Better weather this year and softer inflation in India mean that the purchasing power of rural inhabitants is higher this year than the last. The bank revised its forecast for India’s 2025 GDP to 7% from 6.8% on the back of positive economic data.

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Indian stocks are on track for a big weekly gain this week. The Nifty 50 index is up by more than 2% so far this week. The index has risen 16.83% this year, outperforming the S&P 500 by 25 basis points.

The benchmark 10-year Indian government bond yield has ticked lower slightly to just under the 6.80% mark.

On CNBC TV this week, Sandeep Bhatia of Macquarie Capital said that the geopolitical conflicts globally have not affected Indian markets because of an ample source of domestic liquidity.

Meanwhile, Gurmeet Chadha, managing partner and CIO at Complete Circle, said India’s IPO market has been “pretty hot,” with “steady listings across the last couple of months.” Chadha is also optimistic on India’s pharmaceutical sector because it’ll benefit from the U.S. Biosecure Act if it passes in the Senate.