Sticking to the orthodox process and ensuring continuity of current policy scores well over allowing imbalances to fester. Else the outcome could be quite scary
Given the easy global monetary policies since 2008, some EMs have had an extended party time. However this may now be coming to an end. Given the recent
- combination of higher US rates
- strong dollar and
- rising oil prices
This has resulted in portfolio outflows which in turn has led to rising domestic bond yields. This is a global occurance and countries with twin fiscal and current account deficits have been impacted the most. The case of Argentina, Turkey and Indonesia serves as a warning bell for India.
Given India’s twin deficit and oil dependence, the Indian rupee has been the worst-performing Asian currency so far in 2018 and domestic bond yields have inched higher. Add to this the populist measures on the eve of the budget and an out of control oil price can have cascading effects.
Why this is important
With appetite for risk premium waning, an acceleration of balance sheet and higher bond yields could mean continuance of portfolio outflows resulting in BoP payments crisis or tighter credit conditions. In India’s case given the compulsions of impending elections, the aspirational 3% fiscal deficit target may remain only a dream. India needs to reemaphasis its commitment to this medium term goal.
What needs to be done
Further interest rate hardening to tackle the falling currency is not material given that we attract equity flows more than debt demand. Infact being a closed economy focus should be to manage domestic rates. And given the fragile state of the economy too steep an upward pricing curve could be counter productive.
Further our forex reserves at US 400 bn are ample to ward off any run on the INR US$ rate. However using reserves to defend a particular INR USD rate and allowing reserves to run off would be counter productive and may be viewed negatively by the street triggering more capital outflows.
Given the impending elections market expectations are not very high and government could surprise by going ahead
- with banking reforms,
- sticking to subsidy targets
- reduce government, and
- adopting any measures
that would surprise the street positively and reduce the India risk premium.
In short sticking to the orthodox process and ensuring continuity of current policy scores well over allowing imbalances to fester. The outcome of the alternative is slower growth and sharp rise in the risk premium serving as a deterrent to invest in India