By Divya Shukla
It was a depressing week for the Indian markets, after Rajans maiden policy. The Sensex and the Indian currency (despite rate hikes) continued slipping. He had emphasized on how they could effectively make use of this postponement of the US tapering to set the house in order. All this sounds perfectly like a fairy-tale, but policy-makers in reality may have a hard time in setting the house in order, keeping in mind all the challenges that lie ahead for India.
Firstly, and most importantly, there is a loss of confidence in the markets. Market volatility signals that markets have now become too sensitive too bear even the slightest of negative news (which is contrary to investors expectations), especially from the monetary and fiscal authorities on which hinge great expectations. For instance, most analysts have been saying that Rajan and India have missed the golden chance of healing the economy. Had he lowered the rates by few bps this time, and hiked it in the next monetary review (after US tapering begins) by lesser bps, India would have been capable of attracting huge amounts of net capital flows, from domestic and foreign investors in both phases. A rate cut has now become a need, which if fulfilled could have provided some room to breathe for the investors as well as the government (to work on some long-term sustainable solution). Rates are being continuously increased to tame inflation, but it will only add to the problem by importing inflation owing to rupee depreciation (which was a causal effect of large amounts of FII outflows that followed after the US Fed announcement), resulting in a growth-choke and bringing it closer to the Hindu growth rate unless there is some miracle.
However, many analysts claim that this panic has already been incorporated into the market, and if tapering begins, it wont make much of a difference. Unfortunately, even if we overlook the tapering problem, we cannot ignore the second challenge, which is our competitor- China. Overall, it was indeed a bad time for the Chicago economist to announce a rate hike; no turnaround is expected at least till the end of the year. Consequently, the postponement that had happened this time has and will continue to make the investors all over the world deviate their funds from India to China, where signs of recovery are evidently more substantive.
Thirdly, as stated above, China is steadily picking up its growth rate, as a result of which, there is a surge being observed in commodity (main raw materials) prices- like iron ore and Brent crude. The rupee depreciation and rise in commodity prices will have a cumulative effect on the net income, thus, suppressing the sentiment of the Indian firms.
To conclude, we can say that inflation in one or the other form is going to be a stubborn problem. Currently it is due to easy liquidity in the past (along with structural issues), and rupee depreciation. In future, it will be due to expensive but essential imports. So, monetary tightening will only be adding to the problems of the third largest economy and repeatedly postpone its bottoming-out. As the new governor highlighted the need to put the house in order, announcing a cut in the key rate would have helped to attract money and rev up business sentiments, giving a time-out to New Delhi, to work things out and actually set the economy in order.
A graduate with a Major in Economics degree from the renowned University of Delhi and is about to enroll for Masters program in Financial Economics in Babasaheb Bhim Rao Ambedkar University, Lucknow. Whilst this journey of financial economics is a career career path, has also developed a diverse field of interests, (especially in Economics, Politics, and Finance).