Economic Highlights

New Delhi, 20 December 2013

US Fed Decision

 OUTGO OF FUNDS A CERTAINTY

By Shivaji Sarkar

The breather by the Reserve Bank in holding on to the interest rate is being seen as the possible beginning of a new era though that may not be a great hope. As seen, it’s certainly not a rosy picture for the Indian economy embedded in high inflation, not only in food but even in the general wholesale price index.

The RBI move should hold on to the cost of funding at least for some time. That does not free the path of development particularly as the US Federal Reserve Bank cuts $10 billion in bond buying from the beginning of the coming year 2014. This may create a reverse tsunami of fund flow to the US and a further stronger dollar. In simple terms, many global markets, including India, may have to take a hit as funds are withdrawn for investing in the US.

The RBI in its policy stated that there are obvious risks for waiting for more data; including the possibility that tapering of quantitative easing by the US Fed may disrupt external markets and that the Reserve Bank may be perceived to be soft on inflation. Even though the RBI maintains status quo in its mid-quarter review of monetary policy, it can help guide market expectations through a clearer description of its policy reaction function. If the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the coming times, or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted, so that inflation expectations stabilise and an environment conducive to sustainable growth takes hold.

Federal Open Market Committee (FOMC), the arm of the US Federal Reserve Bank in contrast to its decision of keeping $85 billion a month stimulus programme unchanged in September, 2013 concluded tapering of its Asset Purchase Program to $75 billion starting from January, 2014.

Monthly asset purchases will now include $35 billion in mortgage-backed securities and $40 billion in longer-term treasury (Government) securities, a $5billion reduction in each. However, FOMC says that even after this reduction, longer-term securities will be expanded at a rapid pace, and rolling process of maturing treasury securities and reinvesting of principal payments into agency mortgage-backed securities will also continue. Subsequent to it, the committee asserted that, the federal funds’ rate target will be maintained in its current near-zero range.

This has started creating a scenario where investors fear that chances of a capital flow to the US and a strong dollar are real. It has already caused many currencies to tumble. The most immediate impact was on the Japanese yen, which fell quite a few notches to touch yen 104 to a dollar, one of the lowest in recent times.

Finance Minister P Chidambaram’s hope that India’s increased bilateral currency swap with Japan from $15 billion to $50 billion would help stabilize the rupee is to be seen in the context of the US Fed decision. With the yen falling, the gain of India may also get limited.

In a year, the rupee has lost almost Rs 13. It is finding it difficult to hold on to the present rate of around Rs 62. If it falls further, which seems quite likely, the hope for containing current account deficit (CAD) may get completely lost. The official fall in gold imports may give a kind of window dressing for the CAD, but in reality the higher smuggling and monitoring costs negate the little gains that are seen in “fall of gold imports”.

The stock market has correspondingly shown a fall of 151 points in a day – much more than the perceived gains during the past few weeks. The sensex fell from 20859 to 20708 after the US Fed decision. At the share market banking, capital goods, oil and gas stocks declined the most. It is a sign of the fear that has gripped the market. It fears in the coming days there would be large exit, particularly by foreign institutional investors from the Indian market. The IT and pharma companies gained as their exports are expected to fetch more in rupee terms.

As the US Fed move is aimed at boosting flow of funds to the US, it might create a difficult situation for the Indian economy particularly in terms of foreign direct investment (FDI). The perceived political change in the country too may lead to a situation of wait and watch by the investors. The last quarter of the economy may not be a booming season of activity. Since still most FII and FDI flows come from the West, a crisis-ridden Europe may turn to the US for its recovery. A developing India has many challenges that European investors would best like to avoid.

The Government had a tough task in finding investment in the retail sector. Wal-Mart so far has not agreed yet and the Government is pressurizing UK’s Tesco. Despite an agreement with the Tatas, Tesco is still reconsidering its decision.

It is just not the external factors that are not so favourable. Even internal factors, including headline inflation both retail and wholesale, are concern for the investor. The high energy prices and the latest move to double the gas price for Reliance $4.2 per mmBtu to $ 8.1 per mmBtu is likely to increase electricity and other fuel prices sharply.

This is considered a political decision primarily to benefit the Reliance group at high cost to the people. The decision was taken against the wishes of both public sector power and gas companies. The gain for Reliance would be a direct loss to public sector power generation and fertilizer companies. Overall it would add to inflation. Despite many assurances from the Government this may again create a situation where it might vitiate the conditions for investment.  

Another decision that might alert the foreign investors is that to slap another $604 million tax demand on UK’s Vodafone adding to its tax disputes since it bought Hutchison-Essar in $11 billion (then Rs 51000 crore) in 2007. Undeniably, India needs a lot to more to streamline and steer the economy out of a sub 5 per cent growth. The time is not to cheer yet. ---INFA

(Copyright, India News and Feature Alliance)