Will RBI emulate Fed's moves?

David L Cohen , Director of Action Economics said the Fed held rates as turmoil in the financial markets this week did not justify the departure from what was going to be a steady policy. "There are more effective ways of dealing directly with some of the financial turmoil." He expects the rupee weakening to continue over the near term.

Here is a verbatim transcript of the interview with Sherman Chan and David L Cohen on CNBC-TV18. Also see the accompanying video.

Q: What was your sense about the Fed's move in yesterday's trading session? Do you sense that they did not feel the need or the urgency to go down to about 1% and sort out these credit crisis concerns that are looming in markets right now? Was that some sort of a positive indicator that they did not take any drastic steps yesterday?

Chan: The Fed's decision was consistent with my expectations. Given that interest rates in the US is now only at 2%, they do not have much room to cut interest rates. I expect the Fed to cut rates ahead but they need to be very careful about the timings. We have seen significant global financial market turmoil this week mainly due to financial institutions problems. Cutting interest rates would not really help them in terms of boosting domestic demand or reviving investor sentiment. So they will probably cut interest rates later in the year. But then they do need to cut interest rates sometime this year.

Q: What is your reading of the Fed's statement? What is it indicating in terms of future action?

Cohen: They will see how the data plays out going forward. There have been some hints of a weakening in the economy. Employment reports suggested serious job loss. The Fed felt obliged to refer to that in their statement. At the same time they are down with a lingering risk of inflation and I think they decided that the turmoil in the financial markets this week did not justify the departure from what was going to be a steady policy. There are more effective ways of dealing directly with some of the financial turmoil.

Q: Do you think that we are more or less through with unsteady institutions? Do you think you are not going to get any more such huge bad news like the Lehman and the AIG news? Are we more or less through with that or do you think even that we are only half way through?

Chan: The global financial market turmoil is far from over and this is a very difficult business environment for a lot of financial institutions. So I would not rule out further bad news in the near-term.

Q: Do you think we will now possibly hit a whole interest rate easing cycle in most of the markets and in markets where inflation is pretty high for example the Indian markets if not easing at least rates will be held at current levels?

Chan: The monetary policy cycles in different countries around the world are at different stages. In some Asian countries there still is monetary tightening and I believe India is one of them. I expect another round of monetary tightening in October mainly because inflation is still at a very uncomfortably high level. The tightening bias would be not as strong going forward. Growth momentum has been slowing and they have to be careful in terms of balancing growth and inflation.

Q: Do expect any more steps of tightening at all or do you think it will be neutral from now on and then a cut?

Chan: The RBI will implement another round of tightening in October and then it will be neutral for a few quarters before they start cutting interest rates.

Q: A word about how you expect the Indian rupee to go, are you expecting a serious bout of weakness to continue, or do you think that we have more or less seen the worst?

Cohen: This would depend on the general pattern in the financial markets. The rupee has been under similar pressure along with many of the other emerging Asian currencies in recent months during this flight to safety amid the heightened risk aversion that we have been seeing.

The weakness will continue over the near-term. There still are many clouds on the horizon, and write-downs by financial institutions are not finished yet. So, against that backdrop I suspect that the rupee along with many of the other emerging Asian currencies will continue under pressure.

Q: If you have to rate the US economy currently in terms of its health right now on the datapoints that you have been getting, it has not been so negative on the GDP front, the latest CPI data was also not so negative. But we still get really negative data on the labour front and even on the housing starts front, which dipped 11% in July. Where would we stand currently in terms of the US economy health rating?

Chan: Moody's Economy.com believes that the US has already slipped into a recession in late 2007. The US economy will remain weak probably until mid-2009 mainly because the housing market is still pretty weak and this has downside impact on consumer demand. The labour market has weakened. This will also have a drag on the household spending. All this will have a downside impact on the GDP growth. So, we actually don't expect a recovery pretty much until mid-2009.

Q: What are you looking at in terms of the rupee? Do you think the worst is over?

Chan: I believe the rupee is very sensitive to global financial market developments mainly because India is an emerging market and investor sentiment is very volatile and sensitive to all this financial market turmoil.

So, when there are problems in the US market, there will be a quick repatriation of funds from the Indian market, which is why there has been a strong downward pressure on the rupee. The Indian currency market has already bottomed. I believe there will be an improvement in the rupee in the next few months.