Patient tantrums

A year ago, almost to the date, Reserve Bank of India Governor Raghuram Rajan in a scholarly speech at the Brookings Institution in Washington DC predicted that exits from the prolonged spell of unconventional monetary policies followed by the West, particularly the US, would not be easy. His words came true last week when the Federal Reserve sent out ambiguous signals about the path interest rates would take in the world’s largest economy. The dropping of the word “patient” from its policy guidance lent itself to the interpretation that the Fed was closer than before to a ‘lift-off’ in interest rates, perhaps as early as June. Yet, the statement of the Fed Chair Janet Yellen, almost in the same breath, that the removal of the word from the statement doesn’t imply that the Fed was going to turn “impatient” conveys a certain confusion in policy. Statements highlighting moderation in economic growth and inflation trending below forecasts probably mean that the Fed is still not entirely comfortable with the prospect of hiking rates.

The Fed’s ambiguity could be born out of the surge in the dollar in recent weeks that has messed up its calculations. A strong dollar will not only act as a drag on exports but will also make imports cheaper and depress inflation, especially in an environment of soft oil prices; it will also cramp the room for the Fed to initiate the much-awaited ‘lift-off’ in rates. If the surge in stock prices and the fall in the dollar since the announcement are any indication, the markets have correctly sensed the Fed’s position. The bets are that the first increase will come in September rather than in June, unless there is a dramatic change in environment.

For India, this is good news as it gives more breathing space for both the RBI and the Centre to further shore up defences against the expected volatility when the global economic engine changes gears. India is now undoubtedly in a better place to handle the fallout of a rate increase in the US compared to 2013 when the mere mention of “taper” sent the rupee on a tailspin. Forex reserves at nearly $340 billion are up by a quarter since then and they can be used to counter volatility in capital flows. The current account deficit (CAD) is estimated at a comfortable 1.3 per cent of GDP this fiscal and with crude prices likely to be soft for the next few months, the outlook looks favourable indeed. The only spot of bother is the continuing trend of the fall in exports, which could exert pressure on the CAD, especially if imports rise on the back of economic growth. And then, of course, with growth returning and crucial economic legislations being passed in Parliament this session, the environment may hopefully just be turning favourable for FDI to come in. All of this does not mean that it is going to be smooth sailing in the months ahead. Volatility — in the markets and in capital flows — could well be the norm.

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