Taper II

The US Federal Reserve’s decision to pare its monthly bond-buying programme to $65 billion from February should be read with President Barack Obama’s rather upbeat State of the Union Address delivered on Tuesday. Describing 2014 as a “breakthrough year”, he claimed that the US is “better-positioned for the 21st century than any other nation on Earth” and business leaders globally have declared America, not China, as “the world’s number one place to invest”. The same optimism over “improvement in economic activity and labour market conditions” has guided the US central bank’s announcement of a second successive $10 billion reduction in its monthly asset purchases. The impact of such tapering on India and other emerging markets (EM) — recipients of cheap dollars flowing from the Fed’s printing press — is obvious. But this seems to matter little to US policymakers. The Fed’s statement makes no mention about the ongoing sell-off in many EM currencies because of the global liquidity spigot being turned off.

The eventuality of this happening sooner rather than later is much greater now. Unless the EM crisis becomes serious enough to threaten the US economy, the Fed is likely to keep tapering its purchases of long-term treasury and mortgage-backed securities every month until the programme is totally withdrawn by August-September. The very need for an extraordinary monetary stimulus will dissipate if the currency turmoil in EM economies leads investors to pull out and put their money in US treasuries, thereby keeping interest rates down. The chances of it are higher if the US economic recovery continues to be in line with President Obama’s bullish prognosis. The upshot of this is that the era of easy money is virtually over; funds will henceforth chase only those economies that offer compelling growth prospects.

Where does India stand? There is no doubt it is better placed than most EM economies by virtue of not being a commodity-exporter and probably even benefiting from a Chinese slowdown. This is reflected in the rupee’s relative stability even in the current volatile global financial environment. The Reserve Bank of India’s extreme caution notwithstanding, inflation is also clearly not the threat that it was a couple of months ago. For all the populist pressures in an election year, the Centre is on course to meet its fiscal targets. But financial or political stability alone isn’t going to be enough. Global investors eventually seek real returns and these come only in economies that are firmly on the growth path. A sub-five per cent GDP growth — which is what India looks set for in 2013-14 — is not going to help much when the US economy itself is poised to expand by three per cent. This is one more reason for our policymakers to make growth the primary mandate today.

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