Prepare for the taper

The Fed may unwind its policy soon. India must stop sending out conflicting signals on growth.

After years of living off the Bernanke "put", market jargon for the easy money policy followed by US Fed Chairman Ben Bernanke to revive the economy, the prospect of the Fed beginning to unwind its policy in less than a month from now has sent global markets and currencies into a tizzy. The easy money ensured that US funds moved to emerging markets like India in search of high yields. So, as the Fed tapers off its bond-purchasing programme, and with US interest rates rising, the belief is fund inflows to countries like India will also slow down; between April 1 and August 20, FIIs withdrew $4.7 billion from India. If this isn't bad enough, as Finance Minister P. Chidambaram said in his press conference on Thursday, local factors in India have worsened matters. Between 2008-09 and 2011-12, when India's current account deficit (CAD) worsened from 2.3 per cent of the GDP to 4.2 per cent, strong FDI and FII flows had ensured that the rupee remained stable, depreciating from just 46 to the dollar in 2008-09 to 48.1 in 2011-12. In contrast, while the CAD, to use the numbers put out by the FM, is projected to improve from 4.8 per cent of the GDP in 2012-13 to 3.7 per cent in 2013-14, the rupee weakened from an average of 54 to the dollar in 2012-13 to 64.8 on Thursday.

How the rupee will fare depends on how India attracts forex flows. These, in turn, are partly affected by what the Fed does over the next few months. The minutes of the last US Federal Open Market Committee meeting, released late Wednesday night, suggest high chances of the Fed taper starting next month. With this factor dampening FII flows, a lot depends on how India induces capital flows. Not too many share the FM's confidence on containing the CAD, more so since oil prices have started hardening and there is as yet no sharp hike in prices required to contain consumption. Nor is there any move to bring in private producers to break the Coal India Limited (CIL) chokehold urgently required to lower coal imports that are a high 1 per cent of the GDP. While the FM has said the government is trying to get the courts to restart mining, for local production and exports, forex flows are the key to the rupee.

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