Big challenges remain, but let’s be grateful for small mercies
In the run-up to Diwali, let’s be grateful for small mercies. Back in August, the Indian economy was caught in a vicious spiral of macroeconomic instability. The rupee was falling like a stone. Short-term interest rates had been hiked 300 bps to defend against the currency. This, in conjunction with the rupee at 68, meant that corporate balance sheets were bleeding, runaway fiscal slippage looked the norm, and the quantum of pass-through from the FX deprecation to tradables inflation looked truly frightening. Let’s be grateful that some calm has returned after the storm—both on account of policy actions at home and unexpected but favourable (from the standpoint of emerging markets at least) events globally.
The clearest manifestation of this is the mean reversion and relative stability of the rupee. It’s too early to claim victory until public sector oil demand (estimated to be $5-6 billion a month!) is not introduced back into the spot market. Let’s hope this tapering of oil demand is not as tricky as what the Fed’s going through in its own version of the taper. All that said, there’s clearly good news on the external front. Even including oil demand, the current account deficit in the July-September quarter is expected to collapse to less than $5 billion—from more than $22 billion the quarter before. In fact, September likely witnessed a current account surplus! The quibble, if any, is that some of the structural underpinnings of the current account deficit—coal and scrap metal imports, the lack of iron-ore exports—still remain. So, this is a cyclical narrowing not a structural one. Yet let’s be grateful for small mercies this Diwali. One step at a time.
The relative stability of the rupee has meant that the Reserve Bank of India (RBI) has been able to systematically unwind the emergency tightening measures from July. In all the angst about policy rates going up (more of that below), what’s gotten missed is that the interbank call rate has fallen by 150 bps over the last two months. And short-term market rates are down almost 300 bps from their August highs.
So, with the FX stabilising and the liquidity measures being unwound, we are back to where we were pre-May 22 (the fateful day on which Ben Bernanke hinted at tapering and all hell broke loose in Mumbai, Sao Paulo, Jakarta and Johannesburg). So, what now