)
The ongoing shift in monetary policy to stabilize the rupee may be similar to the situation in 1997-98 amid the Asian financial crisis, said Edelweiss Securities.
The rate tightening by Reserve Bank of India (RBI) then helped currency stabilize, but there was some collateral damage with industrial activity slowing and banks’ bad loans increasing, the firm said.
Continued measures to keep liquidity tight might have similar consequences. Edelweiss said attracting fresh flows through bond issuances would be better than monetary tightening in these times because higher interest rates could further weigh on economic growth.
“This in turn could hurt fiscal consolidation and raise NPAs for banks- thereby increasing the risk of sovereign ratings downgrade,” said Edelweiss’ analysts Kapil Gupta and Toshi Jain in a client note titled ‘Liquidity tightening: Déjà vu: 1997-98?’. But, there are some crucial differences in the situations between then and now.
“In 1996-98, the external shock was due to Asian Financial Crisis, which impacted flows across categories – FII debts, FII equities and loans. International sanctions against India post nuclear tests also contributed to the outflows. This time, it is the fear of QE withdrawal (no financial crisis as such) that is hurting flows, particularly in FII debt flows,” the analysts said.
But, the downturn now is much deeper and current account deficit (CAD) is at historical highs (4-5% of GDP) versus just 1-2% of GDP in 1996-98.
