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Quantitative Easing and Emerging Markets: India 



 As part of an ongoing series on the potential emerging market fallout from a taper in the United States, this week we will examine another of Stanley Morgan’s ‘Fragile Five’ countries: India.

Broadly speaking, India shares many of the economic vulnerabilities of Indonesia, a country that was previously featured in this series. Both experienced currency shocks over the summer as investors braced for an impending taper, and both have been forced to raise interest rates to rein in spiralling inflation at the cost of short-term growth prospects. Like Indonesia, India is also gearing up for national elections in the coming year and the economy will surely transcend all other issues on the campaign trail.

Optimists maintain that one point of divergence between the two countries is direction. India’s stock market has rebounded and economic indicators have turned positive recently. But to the naysayers this is merely a calm before the storm, and the structural problems plaguing the Indian economy will ultimately be laid bare once a taper is announced, whether it’s next week, next year, or beyond.


The Rupee Rollercoaster

As speculation mounted over the summer that a taper was coming, the value of the rupee sharply declined. Between January and September, India’s currency lost 25 percent of its value against the US dollar. And after it became clear that a taper would not be forthcoming, the rupee pared its losses to around 10 percent. The most recent trend has been one of appreciation, as the currency has been strengthening in the first week of December, but if 2013 has taught us anything it’s that things can change in the blink of an eye.

It is difficult to know whether the partial recovery of the rupee was the result of central bank intervention or wider market bets that the taper will be coming later rather than sooner, but Raghuram Rajan, India’s central bank governor, has stressed that India is now better equipped to handle a tightening of US monetary policy than it was in August when the bottom fell out of currency and stock markets.


Current Account Deficit

One crucial indicator that supports the idea of an Indian economy better able to deal with hot money outflows is the country’s current account deficit (CAD). Last week, the Reserve Bank of India (RBI) announced that the country’s CAD had narrowed to $5.2 billion, or 1.2 percent of its GDP in the quarter ending in September. That number is down from $21 billion, or 5 percent of its GDP in the same period last year.

But these numbers have been met with some speculation. Some analysts believe they are based on bad data and others that, bad data or not, recent CAD improvements will be short-lived as import demand is projected to increase in the next financial quarter.

India’s lingering CAD has not hollowed out foreign exchange reserves thus far. Current levels stand at around $291.30 billion, or seven months of imports, and reserves have been rising in recent months thanks to concessional dollar swap deals with regional players such as Japan.



Inflation has become a fixture of the Indian economy, one that is politically explosive given the hundreds of millions of Indians who cannot afford to keep pace with rising food prices. News hounds might remember that the “price of onions” became somewhat of a self-deprecating political meme earlier this year as Indians grappled with a 280 percent price increase in one of their staple foods.

Consumer inflation was 10.1 percent in October, and the RBI is predicting that prices will rise another 13 percent in the coming year.

The government response has been to raise interest rates, which reached 7.75 percent following the most recent hike in October. High interest rates act as a drag on economic growth, and if consumer prices continue to rise as predicted, we will likely see even higher rates next year.


Growth Outlook

The Indian economy posted relatively positive growth figures for the July-to-September period, expanding at an annualized rate of 4.8 percent, up from the 4.4 percent recorded in the previous quarter. The Indian government expects this positive trend to continue and is projecting an annual growth rate of 5 percent for the year ending in March 2014. The International Monetary Fund (IMF) on the other hand is projecting a rate of just 4.3 percent over the same period.

Though the gap separating the government and IMF growth projections means the difference between whether or not a credible case can be made for economic recovery, both pale in comparison to the 7-9% growth rates of recent years - levels that many Indians have come to expect as they adopt China as the yardstick for their country’s economic success.

The drags on Indian economic growth – inflation, high interest rates, flagging reform, and budget deficits – defy any easy answer. Despite recent indications otherwise, there are likely to be more hurdles over the short term before India puts itself on the road to a more robust and long-term economic expansion.


The Political X Factor

These economic problems have mixed with the more perennial issues of corruption and bureaucratic inefficiency to make for a fed up and exhausted Indian electorate; and they will get a chance to voice their dissatisfaction in general elections next May. If recent state elections are anything to go by (often referred to as a “semi-final” before the national contest), then the ruling Congress party is about to be trounced.

The Bharatiya Janata Party (BJP) is eager to capitalize on popular dissatisfaction over the Congress Party’s economic stewardship, and BJP leader Narendra Modi has been flaunting his economic credentials at every possible turn. As chief minister of Gujarat, Modi championed a pro-growth approach and nurtured a reputation for rolling out the ‘red carpet’ for business rather than the ‘red tape.’  Some analysts have taken the prospect of a Modi government as a potential boon for future growth, such as Goldman Sachs in its colorfully-named report ‘Modi-fying our view: raise India to Marketweight.’ Rating agencies Moody’s and Standard & Poor’s have also focused on national elections as a potential turning point for the Indian economy.

But those hoping for an electoral silver bullet to cure what ails the Indian economy may be in for a disappointment come May. Recent elections that carried the BJP to a resounding victory were contested in states the party has traditionally done well in. And Mr. Modi, for all his business-friendly posturing, remains a highly divisive and controversial figure to those who see him as complicit in anti-Muslim violence that erupted in Gujarat in 2002. These factors, combined with the recent success of smaller, regional parties like the Aam Aadmi, or Common Man Party, suggest that the coming electoral reckoning for the Congress Party – itself all but assured – won’t necessarily result in another party assembling the kind of parliamentary majority that facilitates bold economic reform.



Policymakers in India have enjoyed a reprieve following the height of taper speculation in August, and they have seized upon it to ease the rupee along the road to recovery via central bank intervention. But a taper – or at the very least, destabilizing speculation surrounding a taper – is assured at some point in the future, at which point some of the structural economic problems outlined above will inevitably be brought into sharp relief. Just how successfully these problems are tackled hinges on the government that emerges from elections next year, but even in the most optimistic scenarios, it will take a lot of time and painful reform before India can return to the double-digit growth of the past.


Zachary Fillingham is a contributor to 

Tags:  Economy - Asia - South - India

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