Business
The Indian economy needs a dovish Raghuram Rajan (Currency Corner)
By
Vatsal Srivastava The global economy is still very much in the zero interest rate policy
(ZIRP) era with the exception of the US Federal Reserve which is widely
expected to raise rates this year.
Sixteen of 18
industrialized nations have seen their inflation reading run below
expectations as deflationary forces continue to exert pressure on the
global economy. After many years, inflation has cooled off to a level
where India can aggressively begin an interest rate easing cycle to
jumpstart the much talked about cyclical recovery.
Domestic growth sluggish; inflation set to undershoot RBI target
Following
the CPI print of 5.4 percent in February, the consensus view is that
CPI will consistently undershoot RBI’s 6 percent target through 2015 and
average five percent in FY16 according to Citibank. While the monsoon
is a risk factor to these forecasts, the softer inflation readings
should continue on account of lower commodity prices, moderate minimum
support price (MSP) hikes and a deceleration in rural wages. Growth
figures are nowhere close to flattering given the equity valuations the
markets are commanding. Industrial production continued to expand at a
moderate pace of 2.6 percent year on year in January as compared to a
revised growth of 3.2 percent last month.
On a sectoral basis,
mining and consumer goods output contracted by two percent and 1.9
percent respectively in January while electricity and manufacturing
output rose by a meager 2.5 percent and 2.8 percent respectively.
Ongoing
economic reforms and de-bottlenecking of investments will of course add
to our growth rate in the coming quarters but this must be accompanied
by a large fall in the cost of capital. Negative yields made up 16
percent of the JP Morgan Global Government Bond Index following massive
bond buying programs by the ECB and the Bank of Japan. Against this
backdrop, I see no reason why Indian bond yields should not fall to 4-5
percent in two years. For this to happen, RBI governor Raghuram Rajan
must hit the interest rate easing button faster than most expect.
The Fed and the US dollar — Rajan should not worry about a weakening INR
In
the upcoming Federal Open Market Committee (FOMC) due next week, it is
widely expected that the Fed will drop the word "patience" with respect
to monetary policy normalization. This should lead to another leg of a
broad-based greenback rally but my hunch is that the Fed wants to kill
the dollar rally by verbal intervention, at least in the medium term.
The
parabolic uptick in the dollar is hurting corporate offshore earnings
(a 10 percent strengthening in the trade-weighted dollar lowers the
estimated 2015 profit for the S&P 500 by about $3 a share, according
to an earnings model created by Goldman Sachs) and also hammering down
the price of WTI crude which is adding to deflationary pressures. The
Fed should fear that removing "patience" without an offsetting
expression of concern on USD appreciation will lead to another round of
USD buying that would itself make normalization difficult.
There
is a medium-term top to the dollar index at 100-105 in this column’s
view and I see it making a dash to 90-95 first rather than 110. The
federal funds rate futures market is pricing in a June/September rate
hike by Feb chief Janet Yellen. But disappointing retail sales data and
the lack of wage growth in the US labour market may just push this
tightening event into 2016.
Notable market voices such as CLSA’s
Chris Wood and Morgan Stanley’s chief US economist Ellen Zenter belong
in this camp. If it plays out like this, we should expect gradual INR
appreciation. This would support the interest rate easing cycle and if
Rajan eases faster than market consensus, a sharp fall in the rupee’s
value against the dollar should not be one of his major concerns.
Need 100-125 basis points of easing till next budget
We
have seen the bank Nifty sell-off and underperform the broader market
even after two earlier than expected rate cuts. Most of the public
sector banks have been hammered and are trading well below their
adjusted price to book value. The RBI governor has to do more to revive
credit growth and kick start our financial system. Structural reform and
fiscal easing are of course crucial, but we are living in an era where
monetary policy is driving global economic activity. Rajan must also
take cue from the developed market central bankers. He can use forward
guidance and a dovish tone as a macro tool.
Like ECB head Mario
Draghi’s "whatever it takes" and Bernanke/Yellen’s "considerable period
of time, imagine the market impact if Rajan comes out and says: "We will
do whatever we can to achieve 8-9 percent growth, keeping our inflation
target in mind." The recent bounce in crude prices turned out to be a
dead cat bounce and is proof that US oil production is overpowering the
declining rig count, OPEC and geopolitical tensions. Both crude
benchmarks — WTI and Brent - are set to test their recent multi year
lows with no visible catalysts for a sustained V shaped recovery. This
alone should be reason enough for Rajan to go out and ease 50-75 basis
points more than market consensus. Further, we desperately need a cash
reserve ratio (CRR) cut as well so that the banks feel comfortable to
reduce their deposit rates faster.
To be bullish on India, we need a dovish Rajan.
(16-03-2015.
Vatsal Srivastava is consulting editor for currencies and commodities
with IANS. The views expressed are personal. He can be reached at
[email protected])