Janet Yellen plays it smart, can we expect the same from Raghuram Rajan on September 29th?

Acknowledging the recent volatile developments in the global markets, most notably China, and low inflation, Janet Yellen decided to keep US interest rates near the zero bound. This outcome was widely expected by the financial markets as federal fund futures were only expecting a 30 percent probability of a September liftoff.

However, US monetary normalization is inevitable and most likely we will see a rate hike this year. A majority of the committee sees a rate hike sometime in 2015 and Janet Yellen announced that a rate hike policy decision will be followed by a press conference. This implies that an October liftoff is out of the picture and a December move is very much on the cards provided global volatile conditions in the financial markets abate, particularly in China and emerging markets. Yellen reaffirmed that the US labour market remains ‘solid’ and that the committee is confident of meeting its long term inflation target of 2 percent, even though falling energy prices have subdued their outlook for inflation in the short term.

US Fed: Global volatility may ‘restrain economic activity’

The market reaction was mixed but the message is quite clear: US economic recovery remains robust. Expect a rate hike in 2015 but don’t focus too much on the timing of this hike but rather on the path of monetary tightening, which will remain ‘highly accommodative’ according to Yellen.

With the Fed meeting out of the way, and the September 20^th Greek election likely to a non-event for global markets, the domestic focus will turn to the RBI meet on September 29^th. The ball is now in Rajan’s court. He must stop obsessing with the timing of the US Fed hike. Our macros—inflation, current account deficit and foreign exchange reserves are in a much stronger position than they were during the ‘taper tantrum’ in 2013. Of course, there will be an outflow of capital when the US Fed hikes –whether it is in December or early 2016. It’s inevitable and it makes no sense in trying to time the Fed lift-off as India cannot escape its short term consequences.

The RBI must drop its ultra hawkish stance urgently. On Thursday, RBI deputy governor Urjit Patel reiterated that India needs sustained low inflation to achieve a lower cost of capital for the industry. A sharp drop in real rates and the cost of capital is a necessary condition for the investment cycle to pick up. But how soft must the inflation data get in order for the RBI to turn aggressively accommodative? It is highly likely that the RBI January 2016 CPI target of 6 percent will undershoot by a huge margin, which can even be north of 100 basis points.

August CPI printed at 3.7 percent, following a sharp decline in July CPI – which fell from 5.4 percent in June to 3.7% percent in July. According to JPMorgan analysis, inflation momentum – seasonally adjusted quarterly annualized momentum – is down from 6.6% in June to 4.9% in July and a mere 2.7% in August. India’s WPI inflation, currently at minus 4.95 percent entered the negative territory in November 2014 and has stayed in the red since then. This reading will still be in the negative zone even after stripping out the tradable component part.

Raghuram Rajan has missed the bus when it comes to easing monetary conditions. With an inflation outlook which is at best looking bleak, the RBI should now be focusing on accelerating Indian GDP growth towards its potential of 8-10 percent. A 25 basis point cut just won’t do it. To make up for the delay and infuse confidence in the financial system, Rajan will have to deliver a 50 basis point cut along with sounding dovish about the immediate future.