As the US economy gets stronger and the interest rate hike by the US Federal Reserve gets imminent, is India geared up to handle the outflow of foreign money that has been historically ballooning its stock markets?
Christine Lagarde, chief of International Monetary Fund (IMF) who is in India on a two-day tour has said that India is well prepared to deal with any rate hike by the US Fed but cautioned that a stronger dollar may have a significant impact on financial systems in India and other emerging markets.
India's RBI governor Raghuram Rajan, too, has said that emerging markets including India may witness volatility but India is prepared with its forex reserves and lower inflation.
Also Read: IMF warns of huge capital outflows from EMs when US hikes rate
Although, as explained by market efficiency theories, any new information that may have an impact on the subject has to be priced in and that generally leads to an instant overreaction in stock markets.
However, ignoring the short-term reactions, the impact of US Fed policy is going to have a medium term impact as well.
In case the Fed hikes or gives a hint of hiking rates in subsequent meetings later this year, the dollars are going to fly out of India.
Also Read: India well prepared to deal with impact of US rate hike: IMF
This would mean deeper cuts in the Indian stock markets and further strengthening of the dollar.
It must be noted that the dollar has already been on the upswing since the past year and has only fasten its pace over the past few months.
What this means is that your favourite products are likely to get more expensive. Apple Inc has already hiked prices of its phones and computers, if you noticed.
A couple of years ago when the US Fed decided to slow down its quantitative easing (simply put: printing less money), the foreign money from India flew at rocket speed and rupee fell to near 69 levels.
India's current account deficit (CAD) was a record 4.7% to the GDP ($88 billion) in 2012-13 which compounded the problem.
source:
tradingeconomics.com This doesn't seem to an issue today.
Although, CAD for last year was 1.7% and is expected to be at 2.1% for the current fiscal. This is where the problem lies.
As Indian economy grows at a scorching pace of 7.2-7.5% (depends on who you want to believe: IMF's Lagarde or Finance Minister Jaitley), India is going to run a higher than 2.1% CAD next year.
Rupee, currently, hovering and table at 62-63 against a dollar is likely to see a fall.
Inflation, too, has eased paving way for the Reserve Bank of India (RBI) to cut key interest rates twice this year already in a bid to force banks to begin lending to the industry again. This is yet to happen, though as banks stubbornly refuse to cut lending rates.
Moreover, India's fiscal deficit plan has been spread further. The fiscal deficit target of reaching 3% of GDP is now delayed by a year, to 2017. In the wake of kick-starting the economy, Jaitley has decided to print more rupees to pump in the economy.
Amidst all these positive changes since a couple of years ago, only one issue remains: External debt, or India's dollar loans.
source:
tradingeconomics.com A cause of worry is India's high external debt of roughly $460 billion which is securitised against forex reserves which are at an all time high ($337 billion).
This external debt is only going to go up as India and its industry looks to raise more money in dollar terms.
This dollar debt has worked for India must be controlled as India's economic output is still not out of the woods. Stronger dollar is only going to make India's dollar debt balloon further and without proper hedging strategies in place, it is indeed a ticking time-bomb.
Between higher growth, record forex reserves and sharp cut in oil prices, India does look in a better position to handle what the US Fed may offer.
However, oil prices are based on geopolitical realities that may change course faster than a hurricane and dollar debt may force rupee down the painful slide that could derail the growth story.
Investment to revive growth and cutting public expenditure from consumption sectors to growth creation is continues to be India's biggest bet -- which isn't happening at the moment.
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