)
A false calm has prevailed in the Indian markets since September, when the United States Federal Reserve unexpectedly decided that the domestic economy was still too weak for it to begin the “tapering” of its massive bond-buying programme – the third round of “quantitative easing”. The very threat of the taper, made by Fed Governor Ben Bernanke in June, had set off panic in the markets. Every emerging market was hammered, but India was among the worst sufferers.
There were plenty of reasons for India’s vulnerability in mid-2013. For one, its dependence on foreign oil and its appetite for gold imports combined with its struggling export sector to make it an outlier in terms of its current account deficit. In 2012-13, the current account deficit was 4.8 per cent of GDP; at the time, it showed every sign of going even higher.
Meanwhile, the Indian equity market was shallow and dependent on foreign capital, with domestic investors largely sitting on their hands or willing to sell out to foreign institutional investors. Anything that constrained FIIs’ liquidity, like the taper, was terrible news everywhere, but particularly for Indian equity markets, over-dependent on foreign funds. And government borrowing in India was also high; that meant the turmoil in the bond markets caused by the sudden spike in US treasury-bill yields – which jumped up by 150 basis points in no time at all – affected Indian bond markets relatively more.
There were plenty of reasons for India’s vulnerability in mid-2013. For one, its dependence on foreign oil and its appetite for gold imports combined with its struggling export sector to make it an outlier in terms of its current account deficit. In 2012-13, the current account deficit was 4.8 per cent of GDP; at the time, it showed every sign of going even higher.
Meanwhile, the Indian equity market was shallow and dependent on foreign capital, with domestic investors largely sitting on their hands or willing to sell out to foreign institutional investors. Anything that constrained FIIs’ liquidity, like the taper, was terrible news everywhere, but particularly for Indian equity markets, over-dependent on foreign funds. And government borrowing in India was also high; that meant the turmoil in the bond markets caused by the sudden spike in US treasury-bill yields – which jumped up by 150 basis points in no time at all – affected Indian bond markets relatively more.
Many expected the Fed would not actually begin the taper till March. But the smart money was always with Harvard Professor Martin Feldstein, who said over a month ago that, before Bernanke left office, he would want to start unwinding the unusual monetary policy instruments he had set in motion. That’s what’s happened now. The question is: is India as vulnerable now?
The government thinks not. The minister of state for finance and the economic affairs secretary have both insisted that the Indian economy is much better insulated from the effects of the taper today than it was months ago.
ALSO READ: 10 key takeaways from FOMC meet
To an extent, they’re right. It’s certainly the case that draconian restrictions on gold imports and the slow recovery of Indian exports have together helped mend the current account deficit, which was 1.2 per cent of GDP in the July-September period. So to hassled currency traders selling emerging-market currencies, the rupee won’t be as tempting a target as it was earlier. Growth has also recovered marginally, showing an increase for the first quarter in a very long while. And the taper that the Fed’s announced, a $10-billion reduction in its $85-billion-a-month programme, with no timeline for speeding it up or further cuts, is not sharp enough to cause much panic.
But it’s difficult to argue that India will be unaffected. For one, the Reserve Bank of India(RBI) bravely refused to raise interest rates further in its monetary policy review on Wednesday. On the one hand, that means that India is vulnerable to another spike in the US T-bill yield; on the other, it means that the RBI does at least have that weapon in hand.
For another, the equity markets have not kicked their dependence on foreign money. The benchmark indices have hit record highs – but they’re composed largely of stocks that foreign investors love. Domestic investors are still grumpy about equity, as is clear from the continuing problems faced by mid-cap stocks that are typically traded mainly by Indians.
Perhaps, however, the biggest difference between mid-2013 and today is intangible: it’s hope. Raghuram Rajan, for example, looks like he’s on top of his job and investors are disposed to trust him. And the battered central government is nearing the end of its term. Many hope that it will be replaced by a more efficient and dynamic political formation. If the markets handle the actual taper better than they did its mere announcement, then that’s not only because of things the government may have done; it’s because the markets can see it heading towards the exit door.
mihir.sharma@bsmail.in
