<b>Devangshu Datta:</b> Merely a short-term relief

With the Fed putting off a dollar rate hike, the buck has passed to RBI, which may cut repo rate on Sept 29. Riding on the hope, the financial sector is buoyant. But the long-term trends seem bearish

The US Federal Reserve sparked off a relief rally as it performed another of its popular imitations of a dove. The Fed deferred a dollar rate hike, which was expected by about a third of market participants. But the rally did not last long, as markets noticed a doom-and-gloom component to the statement.

The statement read, "Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term." Chairperson Janet Yellen also emphasised that overseas fragility played a role in shaping the Fed's stance in her press conference. The Fed does not see its target of two per cent inflation being hit before 2018. But robust American job growth and solid gross domestic product (GDP) performance means that a raise could come much earlier, maybe even in December.

Elsewhere, quite apart from ongoing, well-publicised issues in China, the news was bad. Brazil has been hit by a sovereign rating downgrade from Standard & Poor's, which has pulled Brazil's rating down to junk. France has seen government debt down-rated by Moody's. Japan's public debt has been downgraded by three rating agencies. More downgrades are feared across many emerging markets including Russia, Turkey, South Africa etc. Every downgrade triggers capital flight to safety (meaning US treasuries).

Global growth estimates are being pared down. The Organisation for Economic Co-operation and Development has cut its global GDP estimate from 3.1 per cent to three per cent. And, Goldman Sachs has outlined a scenario where international crude prices might collapse to the $20/barrel level (this is not the base, high probability case in Goldman's analysis).

In India at least, the Fed holding steady passes the buck squarely to the Reserve Bank of India (RBI), which is now expected to cut the rupee repurchase rate at its next policy meeting on September 29. The case for cutting the repo is strong. Inflation seems to be tamed. The Consumer Price Index (CPI) saw a year-on-year change of plus 3.6 per cent for August 2015 over August 2014. That's a nine-month low on the CPI and it was backed by the Wholesale Price Index hitting a historical year-on-year level of -4.95 per cent.

The low year-on-year is partly due to a base effect - crude was trading at over $100/barrel in August 2014. But if crude and gas prices do stay low, and there's overwhelming consensus on that, inflation is unlikely to spike anytime soon. Bank credit offtake is also low . Cutting interest rates could provide a growth stimulus, assuming banks pass it on.

A rate cut would also weaken the rupee in all probability. That might be necessary, given the terrible trend in Indian exports, which have fallen every month through the last nine months. China has started a process of yuan devaluation and that is likely to set off copycat devaluations in Korea and other east Asian export-oriented economies.

In his latest public appearance, RBI Governor Raghuram Rajan did not rule out a rate cut. But he referred to Brazil as a cautionary tale, where efforts to stimulate growth through monetary policy had led to the current downgrades and GDP contraction.

Even if the RBI doesn't cut in September, it could cut in January. The stated retail inflation target of year-on-year change of below six per cent in January 2016 (more specifically, CPI for December 2015 staying within a year-on-year band of between four-six per cent) is likely to be met easily.

Indian corporates have been looking to borrow at lower rates via the bond market, or through overseas commercial borrowings. However, banks would have to pass on the cuts and that hasn't happened on the three previous occasions when Rajan eased.

It is difficult to judge how well the Indian economy is doing. The value-added calculations of GDP have not really settled to the point where they seem reliable. Corporate earnings have been flat or negative for three quarters. The Index of Industrial Production has only started to pick up recently and it suggests slow, gradual recovery.

GDP growth of seven per cent plus seems unlikely. The monsoon failure will surely lop off some expected growth, whatever the prior estimates. Also, forecasts for 2016-17 will be cut on the basis that some reform expectations were built in, and those are clearly not coming through.

However, on the plus side of the ledger, it seems households are allocating a larger share of savings to the stock market and other financial assets. That is also evident in the buying patterns of domestic institutions which have put over Rs 51,000 crore into the equity market in the last nine months. This could help fuel faster GDP growth even if foreign direct investment inflows don't accelerate and foreign institutional investors remain net sellers through the fiscal, as they have been since May.

At the political level, the Bihar Assembly elections are an important bellwether. Hopes of reform may revive if the ruling Bharatiya Janata Party (BJP) does enough to suggest it can improve its position in the Rajya Sabha through the next two years. But it would be a setback for reform hopes if the BJP cannot replicate its 2014 general elections performance.

Technically speaking, the Indian market is now riding on the hopes of a rate cut. This could keep the financial sector buoyant and the major indices afloat until September 29 at least. But the indices are trading well below their own 200 Day Moving Averages and index investors have seen net losses for the last six months. The long-term trends still seem to be bearish.