Fed Rate Cut Hopes By March Are ‘Optimistic,’ Rajan Says

(Bloomberg) -- The US Federal Reserve will probably want to see inflation come down further before easing policy and any expectations of interest rate cuts by March are “overly optimistic,” India’s former central bank Governor Raghuram Rajan said.

While inflation in the US is slowing, it’s not easing at a fast enough pace that would give the Fed comfort to shift policy, Rajan, who is now a professor of finance at the University of Chicago Booth School of Business, told Menaka Doshi at a Bloomberg India Edition newsletter event in Mumbai.

“The Fed would like to see either a substantial fall in inflation, but also, the problem is the labor market is hot,” Rajan, who is a well known commentator on the global economy, said Wednesday. “The Fed may think if rates are not doing damage, why worry.” 

The Fed is widely expected on Wednesday to keep interest rates unchanged at its last policy meeting of 2023. Economists surveyed by Bloomberg expect the Fed’s projections will show two rate cuts next year and five more in 2025. 

Keeping rates higher for longer will come with its own risks, Rajan said. Credit card debt and auto loans in the US are a concern and smaller banks are showing signs of stress, he said. 

Central banks across the world are projected to shift gears next year after an era of aggressive rate hikes. A key concern is whether policymakers can pivot quickly enough to blunt the impact of past tightening and avoid a severe downturn in their economies.

It’s very “hard for the Fed to land the economy right on deck,” Rajan said. 

He was speaking at the event alongside Rohit Lamba, an economics professor at Penn State University, co-authors of a recently published book on the Indian economy, titled “Breaking the Mould: Reimagining India’s Economic Future.” 

The authors, in the book, argue that India should focus on building its value-added services export industries, such as global capability centers, instead of a policy slant toward low-value manufacturing, where profit margins are shrinking and competition is intense.

Cautious Optimism

Rajan said that while India’s growth is holding up, private investments and consumption are still weak. “All that suggests we cannot be overly optimistic, but cautiously optimistic,” he said.

India’s central bank expects the economy to grow at 7% in the fiscal year ending March. While that’s a world beating performance, it’s still not enough to absorb the millions of people entering the job market every year. A World Bank report estimates about 12 million youth will enter India’s workforce every year over the next two decades.

“At a 6% potential growth rate, over 24 years, we will become a $10,000 per capita economy. We’ll be still below China today,” Rajan said, batting for a focus on India’s dominant services sector to create more employable people. 

Rajan, 60, was governor of the Reserve Bank of India from 2013 to 2016, during which time he helped avert a currency crisis in the country and took stern measures to force banks to reveal their hidden debt. He left the RBI two months before Prime Minister Narendra Modi’s controversial decision in 2016 to ban high-denomination currency notes. He’s been a vocal critic of the government’s economic policy while at the RBI and since he left.

India is providing financial incentives worth billions of dollars to promote domestic manufacturing in the country. While firms like Apple Inc. and Samsung Electronics Co. have started building more products in the country, the share of manufacturing in India’s gross domestic product stands at about 13%, well below the 25% goal.

Modi’s ambition is also to build India’s $3.4 trillion economy, currently the fifth-biggest in the world, into a $5 trillion economy by 2025, which would be the third largest. To achieve that, India’s economy would need to grow at a faster pace than it’s doing now.

Barclays Plc estimates India needs growth of 8% a year over the next five years to match China’s contribution to global growth. Even so, China’s economy at $18 trillion continues to dwarf India’s.

(Updates with more details on Rajan’s views on India)

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