India can withstand monetary policy normalisation by large economies, says Economic Survey

Economic Survey 2022-23 Main Highlights: With forex reserves of over USD 630 billion and plenty of “policy room” to deal with the situation, India can withstand normalisation of monetary policy by central banks of large economies like the US Federal Reserve, the Economic Survey said on Monday.

The survey noted that due to accretion of large foreign exchange reserves in recent months, vulnerability indicators relating to reserves such as reserves to total external debt, reserves to short-term debt (residual maturity) and reserve cover of imports have shown marked improvement in the first half of the current fiscal vis-à-vis FY 2014, the taper tantrum year.

Taper tantrum phenomenon refers to the situation in 2013 when emerging markets witnessed capital outflows and spike in inflation after the US Federal Reserve started to put brakes on its quantitative easing programme. The US Federal Reserve has indicated interest rate hikes and other measures aimed at getting inflation under control. It has officially announced the start of its monetary policy “normalisation” plan.

Another key vulnerability indicator — net IIP to GDP ratio — has declined to (-) 11.3 per cent as against (-) 18.2 per cent in the said period, the survey noted, adding the external debt to GDP ratio has also declined since the taper tanrum of 2013.

Besides, it said, India witnessed a current account surplus of 0.9 per cent in the Q1 of 2021-22 on top of similar surplus in 2020-21 after a gap of 17 years.On the other hand, it said, India experienced the highest ever current account deficit of 4.8 per cent of GDP in 2012-13 on the back of an equally large deficit of 4.3 per cent during the previous year (2011-12).Evidently, the Indian economy has exhibited greater resilience so far to the current episode of taper.

In the immediate aftermath of the taper tantrum in 2013, it said, India experienced portfolio outflows aggregating to Rs 79,375 crore from capital markets, including Rs 19,165 crore from equity markets and Rs 60,210 crore from debt markets during May 23-August 30, 2013. The latest announcement of reduction in asset purchases on November 3, 2021 by the US Federal Reserve had relatively muted impact on portfolio flows, it said, adding the total portfolio outflows amounted to Rs 34,178 crore, comprising Rs 29,168 crore from equity markets and Rs 5,010 crore from debt markets during the period November-January 20, 2022.

“While acknowledging India’s transformation from being among the Fragile Five countries in the wake of the earlier episode to the 4th largest forex reserve holder during the current episode, Indian economy stands guard with an added advantage of plenty of policy room for manoeuvring as the process of normalisation of monetary policy by systematically important central banks takes hold,” it said.

In response to the pandemic, since June 2020, the US Federal Reserve had been buying USD 80 billion of treasury securities and USD 40 billion of agency mortgage-backed securities each month.

In late July 2021, the survey said the US Federal Reserve signalled that it would start reducing the volume of its bond purchases later in the year.On November 3, 2021, it said, the Federal Open Market Committee unanimously voted to scale back its asset purchases. In line with this, the Reserve Bank of Australia (RBA) has also abandoned its yield curve target.

As yields on government debt climbed, the RBA chose not to intervene to defend its target of 10 basis points for debt maturing in April 2024. Bank of Canada has gradually tapered its asset purchases in recent months.

“Thus, the long-awaited taper process has commenced by the systemically important central banks, renewing thereby an element of interest – within the academia and policy circles – in the potentially destabilising spill-over impact on the emerging market and developing economies as also for India,” it said.