RBI cited the market perception of the US Federal Reserve (Fed) tapering off its QE (Quantative Easing) program as the reason for FIIs pulling out over USD 7.5 billion out of Indian Debt and Equity markets over the last couple of months. The central bank then went on to tighten liquidity to give strength to the Indian Rupee (INR) that had depreciated by over 11% to all time lows.
RBI’s liquidity tightening measures are now threatening India’s economic growth and economists are busy lowering growth forecasts to levels of even below decade low 5% growth seen in fiscal 2012-13.
The fact that RBI tightened liquidity after a meeting of the PM, FM and RBI Governor did not escape markets as RBI’s measures were announced late in the evening on the same day of the meeting on the 15th of July 2013. The PM and the FM would have definitely impressed on the RBI that the Fed is responsible for the INR weakening and the central bank must act in haste.
The point here is that basing a monetary policy response to an action of the Fed gives rise to the question of whether the Fed is to be held responsible for the woes of the INR? India’s economic independence is being questioned here and will the country always move on the actions of the Fed?
The Fed is an American Institution and its sole concern is for the US. The Fed’s monetary policy is dependent on its perception of the US economy. Fed will never look into the repercussions of its actions to economies across the world. Fed will throw money into the system and will pull it out based on US economy outlook. Fed’s actions do affect the rest of the world but as far as the Fed is concerned it is up to individual economies to adapt to the world economic environment. The Fed will never make excuses for its actions and its effects on the rest of the world.
Indian policy makers cannot expect the Fed’s actions to be positive for the country always. Loose Fed monetary policy leads to flows of liquidity into the country leading to growth, inflation and asset bubbles. Government is happy with growth and asset bubbles but cannot handle inflation and that is left to the RBI to handle. INR strengthening due to liquidity flows is fine with the government as it takes credit for that but INR weakening due to liquidity outflows is not fine and the government blames the Fed for that. RBI should let the INR strengthen but should not let the INR weaken is the motto of the government.
The FM. P. Chidambaram had issues with Dr. Y.V. Reddy when he tempered INR’s rise and now he is fire fighting a weakening INR that is brought about largely due to domestic policies rather than the Fed’s action.
India’s fiscal deficit is due to poor subsidy policies of the government. India’s CAD (Current Account Deficit) is due to inflation and again poor subsidy policies of the government. Fiscal deficit and CAD is seen as the biggest contributors to the INR fall. Not Fed’s policies.
The government should reflect and hasten measures to control its fiscal and current account deficit. To a certain extent there is an eye on the deficits and there are conscious efforts to bring down both the deficits but that will take time.
The INR in the meanwhile will react to growth expectations in the economy and with the government fire fighting on deficits, growth will take time to bottom out and stabilize. The sooner that this realization dawns on the government the better as then it can let RBI take monetary measures based on growth inflation dynamics rather than based on Fed’s policies.