Forex reserves robust, the current account in good shape, and if India joins a global bond index, FPI outflows can be contained
There was no clear guidance but US Federal Reserve chair Jerome Powell did hint, at the Jackson Hole meet last week, the Fed might consider a taper of asset purchases later in the year. Even as there has been steady progress towards full employment in the US, there is some ground to be covered. However, with Fed’s aim now to hit inflation of 2% on average—rather than at every point in the cycle—some tapering could begin in late 2021.
To be sure, Powell’s address did not set out any specific timelines for scaling back the purchases that are not insignificant (at $120 billion a month) and were initiated last year to infuse liquidity into the economy. Nor were there any indications about the quantum by which purchases may be lowered. But economists expect a calibrated normalisation over a long period.
Indeed, the Fed Chair observed that while the economy was on a strong path, all data would be carefully studied to gauge how potential risks; one of these could be the Delta variant of SARS CoV-2 that could derail the progress of a somewhat uneven recovery. Also, inflation concerns haven’t altogether vanished and might not turn out to be as transient as supposed; inflation was elevated both in June and July at 5.4%, but Powell believes that once supply-side issues are sorted out, price pressures will subside.
One will, of course, get a much clearer picture at the next FOMC in late-September, but the fact that the stock markets are celebrating indicates there is little anxiety. That is probably because they believe any normalising would be very gradual and that rate hikes are far away since the Fed would not want to risk hurting the recovery. Also, even though the world is emerging from a severe pandemic, the repercussions of the taper are not expected to result in the kind of tantrums witnessed in 2013.
For India in particular, the phased withdrawal of asset purchases by the Fed, should not pose any serious problems. The country’s forex reserves are a robust $600-billion-plus. The current account (CA) is in good shape and, as of now, is expected to turn into a relatively small deficit of less than 1% of GDP in FY22, from a temporary surplus of 0.9% of GDP in FY21. FPI inflows were a record $25 billion in 2020, on the back of $14 billion in 2019, and continue to remain strong.
Even if there are some outflows from the equity and bond markets, it should not send the currency reeling. Should India join one of the global bond indices, as is expected, it would help contain outflows. Moreover, FDI flows too have been remarkably strong over the past few years and, consequently, India could see another year of a strong BoP surplus of around $55 billion. Indeed, India is nowhere close to the precarious position that it was in in 2013 when it was part of the Fragile Five.
Its problems are a high public debt and nagging inflation; any nasty surprises on this score could upset RBI’s calculations for a calibrated withdrawal from its accommodative stance. Some small steps have already been taken, the reflection of which can be seen in the yield on the benchmark that has inched up to 6.5%. Given the government is being extremely careful on expenses and revenues, so far, are well above targeted collection levels, the fisc should not slip from the projected 6.8% for FY22. In sum, right now, it looks like India can take the taper in her stride.