Wednesday, September 11, 2013

QE reversal: does India face a financial emergency?

This is the question more than one reader of this blog has posed to me in recent weeks. I hope the appreciation of the rupee and the rise in the Sensex in recent days has assuaged their concerns somewhat. My own view has been that, yes, it is a challenging time but hardly cause for panic. The fall of the rupee below Rs 65 was a case of overshooting, so it is no surprise to find it oscillating between Rs 60 and Rs 65.

I guess the key question is: what happens when the Fed reverses QE? It is expected to make its intentions clearer on September 18. There is a view that this will unleash a tidal wave of withdrawal of funds that will devastate emerging markets, as in the East Asian crisis of 1997; India is in for a beating.

I had a look at the data on FII flows, and I am not persuaded. Since end May, when the Fed first gave indications of tapering the QE, only $3 bn has left the equity market (until September 6); most of the flight has been on account of investment in debt, $9 bn. Cumulative FII investment in equity is $137bn at the moment; that in debt only $28 bn. Even if more of the investment in debt leaves, that is not an issue. We face a serious problem only if there is an exodus of equity. The considerations underlying debt flows are quite different from those underlying equity flows. Debt will flee the moment interest rates in the US and the advanced world perk up; equity flows will flee only if growth opportunities change dramatically.

In the East Asian crisis, the exodus happened mainly account of foreign bank loans (which is similar in characteristics to FII investment in debt) and domestic residents taking their savings abroad, thanks to full capital account convertibility. (That is why the reduction in annual remittances of Indians from $200,000 to $75,000 is a sensible move). FII flows were not a crucial factor in the  East Asian exodus.

There are other differences as well between East Asia in 1997 and the current situation. I highlight these and make the point that emerging markets remain vulnerable in the long-term to advanced economy monetary policies unless they impose some restrictions on volatile capital flows- all this in my article in the Hindu, Easing troubles in the long run.

6 comments:

Anonymous said...

Thank you for addressing our question ....hope the government heeds to what you say...structural reforms should be at the forefront...

Anonymous said...

Sir can you please explain as to what is meant by "rupee is well corrected"? I have been hearing enough of this recently. Does this mean rupee will sit at Rs 60 a dollar forever now?

T T Ram Mohan said...

Anonymous, The rupee is "well corrected" means the present level - whatever the writer was referring to- is the correct level. There will no further appreciation or depreciation from this point.

-TTR

Anonymous said...

What a shame and burden to Indians that dollar would be at Rs 65 now.

Anonymous said...

well rangarajan has gone senile now. he should retire and take care of himself. he has done nothing for india.

Ambit Holdigs said...

Drop in rupee price is shocking news. But if we don’t buy gold then government saves lot of import duty which will stop rupee lowering.