Economy needs a dovish Rajan

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.Following the CPI (consumer price index) print of 5.4 per cent in February, the consensus view is that CPI will consistently undershoot RBI’s 6 per cent target through 2015 and average 5 per cent 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 per cent last month. On a sectoral basis, mining and consumer goods output contracted by two per cent and 1.9 per cent 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 per cent of the JP Morgan Global Government Bond Index following massive bond buying programmes 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 per cent in two years.

For this to happen, RBI Governor Raghuram Rajan must hit the interest rate easing button faster than most expect.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 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 per cent 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.

By Vatsal Srivastava