Tapering worries

Finally, the much-feared ‘taper’ has arrived, with the US Federal Reserve announcing a scaling down of its purchases of treasuries and mortgage-backed securities to $ 75 billion in January from the current $ 85 billion-a-month levels. This could be the beginning of a phased reduction in its monthly bond-buying to zero over the next year, ending an extraordinary monetary stimulus programme involving central bank purchases of long-term financial assets. The withdrawal of this source of global liquidity has obvious consequences for India and other emerging economies that have been recipients of the resultant cheap dollars.

But unlike in end-May, when the Fed Chairman Ben Bernanke first spoke of ‘tapering’, India is much better prepared to deal with the consequences of a capital outflow today. When that statement was made, the country’s current account deficit (CAD), which stood at a dangerous 4.8 per cent of GDP in 2012-13, had further widened to 4.9 per cent in April-June. The spectre of an out-of-control CAD made India vulnerable to outflows and speculative currency attacks. Bernanke’s suggestion of tapering provided only the trigger, with foreign institutional investors (FII) selling $13 billion worth of Indian equities and debt over June-August. This period also saw the Reserve Bank of India’s foreign currency assets fall by $11.1 billion and the rupee plunging to a low of 68.36 to the dollar. But the situation has turned around dramatically since then. Between September and now, FIIs have made net investments of almost $ 4 billion, the rupee has strengthened to around 63.5 to the dollar and the RBI’s forex chest has expanded by $21.4 billion. Underlying this improvement has been a drastic reduction in the CAD to 1.2 per cent in GDP in July-September and the RBI’s concessional swap facilities for banks, which have helped mobilise some $ 34 billion in non-resident deposits and overseas borrowings.

A lower CAD, coupled with the RBI being in a better position to intervene, means India is less vulnerable to capital outflows from increased interest rates in the US on account of a rollback of the monetary stimulus. The threat is also mitigated as the Fed proposes to continue injecting monetary steroid; it’s only the dosage that has been reduced for now. Also, the Fed has committed to keep its benchmark federal funds rate at sub 0.25 per cent levels even after the current asset-purchase programme has ended. In other words, the era of cheap money isn’t going to be over soon. But for India to attract these funds, it isn’t enough to just assure foreign investors that their capital is protected against a weak rupee. Investors ultimately want ‘real’ returns, which can only come when the economy is firmly back on the growth path.

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