This is the first rate cut since the autumn of 1998 when a global economic crisis threatened to seize up world financial markets. The US equity markets have responded warmly to the measure as it triggered a 232 points increase in the Nasdaq Composite Index to 2523 or 14 per cent, its largest gain, both in points and percentages, ever since it was founded in 1971. Dow Jones, the oldest index, advanced by 299.60 points to 10,945.75 or 2.81 per cent, its eighth largest point gain.

Major bourses in the world reacted with enthusiasm to the cut. Sensex gained 55.35 points to close at 4115.37 on Thursday. Major IT stocks and Hindustan Lever made gains that ranged from 3 per cent to 8.62 per cent. It remains to be seen whether the American economic makes a softlanding. But the effect of the cut on the global economy is likely to be positive especially most economies look to the American economy for succour. With this measure, Greenspan has given them a life breather.

In fact, many analysts were hoping for the rate cut to save the global economy from a slowdown. This was because tight financial conditions dampened global investment climate and high oil prices only worsened slowdown in global growth.

Salomon Smith Barney (SSB), in its Gyrus 2000 for December 2000 report, did point to a possible easing of the US rates but did not expect it to come so soon. Its projection was based on the expectation that a long-term trend toward more powerful self-correcting market forces would encourage "creative destruction" and sustain economic growth. It observed, "as financial conditions tighten, the odds are that the US Federal Reserve will lower interest rates at least modestly in 2001."

The economic forces, the report spoke of, include open trade, dynamic capital markets, widespread deregulation, reduced fiscal activism and accelerating innovation that helped the US expansion in history. Apparently fear of inflationary pressures dictated dear money policy for such as long time in America. But the latest rate cut seems to have been prompted by the weakening of sales and production, sagging consumer confidence and lower business expectations in that country. Recession and eventual depression can be lethal for the economy as Japan currently proves it so well.

Therefore, the rationale, "the crises of economic weaknesses in the foreseeable future exceeded the risk of inflation." The President-elect George Bush added a titillating note with the hope that the cut will provide the much-needed dose of `economic viagra.'

Much depends on how the Fed views inflation that has been crucial in deciding its policy focus. The latest rate cut and the promise of more to come in the future are linked to the behaviour of inflation. SSB says, "The US Federal Reserve still regards higher inflation as the leading policy threat. However, in the absence of a new oil shock the balance of risks is shifting rapidly in the opposite direction. We expect the Federal Open Market Committee (FOMC) to abandon its policy bias soon. The key question is whether the prospective economic slowdown will be sufficient to prompt Fed easing in 2001."

There are interesting similarities between the Indian and the US economic conditions. The slowdown has been a major consideration behind the rate cut. For a long time the Indian industry has been urging the government to slash interest rate to spur investment and stimulate the economy. But the Reserve Bank of India governor Bimal Jalan does not believe that what is good for the American goose must be so for the Indian gander. Much will depend on the forthcoming budget.

On balance, it seems the world may move towards a stable economic environment helped by the US easing on rates in the course of the current year. The reason is, since 1998 the global economic situation has improved substantially. If anything, oil price hike did hurt it by raising the bogey of inflation. A few imponderables do remain that raise risk aversion. This is also noticeable in India.

SSB expects the Fed to cut the fund's rate by around 50 basis points in first half of 2001. But in that scenario India may have to face further weakening of the rupee. The FIIs may move to the US equity market, thus leading to pressure on foreign exchange. In that event, the forward premia are likely to widen further on the basis of pure interest rate differentials and also the rate differentials. The trend is already visible. Exports may play a crucial role in the near future.

SR Kasbekar