The QE (quantitative easing) ‘tapering’ – though coming earlier than anticipated – has not led to the kind of turbulence that a mere indication/hint about this had led to in May, 2013. The impact on emerging market economies (EMEs) including India is minimal.
Contrary to expectations that quantum of tapering would be steep viz., reduction in asset purchase by US$ 20-30 billion per month, US Fed has announced a reduction of US$ 10 billion a month – commencing January, 2014 – from current US$ 85 billion per month.
The FOMC has also alluded to proposed wind down being ‘gradual’ and ‘calibrated’. Thus, unlike May when uncertainties gripped the scene, this time around there is an element ‘predictability’ and ‘certainty’. This has helped a lot.
US Fed has also decided to keep interest rates at existing low levels despite a significant improvement in GDP (growth during 3rd quarter was 3.6% against 2.8% expected) and un-employment (currently at 6.5%). This will ensure that funds are not pulled back to USA.
Indian policy makers are in a buoyant mood even as the BSE-sensex is only marginally down by less than 1% and the rupee too has not been severely impacted. They also exude confidence that India is much better prepared for QE tapering.
Finance Minister has opined that India is much less vulnerable in view of CAD slipping to 1.2% GDP during the second quarter of current fiscal and the whole year CAD likely to be well within comfort zone of 2.5% (against 4.8% in 2012-13). This offers little ground to get enthused.
Lower CAD is primarily a manifestation of sluggishness in GDP growth. On top of a precipitous decline to 5% during 2012-13 (from 6.5% during 2011-12), during the first 2 quarters of 2013-14, this is down to 4.4% and 4.8% respectively. The rating agencies do not expect it to cross 5% for the whole year.
A huge decline in gold import has also contributed to lower CAD. The reduction is primarily due to steep increase in import duty (from extant 2% to 10%) and physical controls (e.g., 20% of gold imported has to be kept in custom warehouse for export) – reminiscent of ‘pre-reform era’. That is not a healthy sign at all.
These controls need to go sooner than later. Likewise, GDP cannot remain stuck in groove. It has to be resurrected; indeed, Government intends to push it beyond 6% during 2014-15. Therefore, the real test is next year when US Fed would terminate QE 3 – most likely by December, 2014.
In regard to the health Indian rupee, we are yet to come out of the mayhem that followed initial signalling of QE taper in May that led to exodus of US$ 12 billion in just 3 months; over 75% of this from investment in debt/bonds alone.
Since September, FIIs have come in (US$ 4 billion invested till date) but that is largely in anticipation of Modi-effect viz., possibility of a stable Government led by NDA (National Democratic Alliance) next year under leadership of Mr Narendra Modi.
It has little to do with underlying economic fundamentals which continue to be weak. Even our foreign exchange reserves at around US$ 295 billion continue to be fragile (these cover only 7 months import requirements). These are far from giving us required resilience to deal with situations of stress.
Much ado is made about concessional ‘Swap’ window to attract funds in to FCNR (B) account and borrowings by bank abroad under Tier I capital. The window now closed (end November) garnered US$ 34 billion. This is mainly due to currency risk assumed by central bank.
The rupee also got some prop up from an unusual decision to allow oil PSUs to meet their dollar requirements from RBI. This ingenious step eased pressure on market for a while. Government merely ‘deferred’ problem to a future date.
In a nut-shell, whatever resilience and semblance of stability that we see in Indian currency is the result of some engineering in foreign exchange management. These are short-term palliatives and won’t sustain in the medium to long-term.
India can countenance a potentially turbulent situation – likely from middle of 2014 onwards – only by taking some harsh measures to combat endemic problems of ‘fiscal profligacy’; ‘inflation’ and ‘languishing investment’ and thus improve our economic fundamentals.
Unless Government acts decisively, we could face a disaster when the QE 3 is fully withdrawn come December 2014!