Economic Survey: External sector resilient to Fed moves to combat inflation

Survey says salient external sector sustainability indicators are strong and much better than what they were during the global financial crisis or taper episode of 2013

India’s external sector is resilient to face any unwinding of the global liquidity arising out of the likelihood of faster normalisation of monetary policy by systemically important central banks, including the Fed, in response to elevated inflationary pressures, the latest Economic Survey said.

In response to the pandemic, the Fed had been buying $80 billion of treasury securities and $40 billion of agency mortgage-backed securities (MBS) each month since June 2020. In late July 2021, the Fed signalled that it would start reducing the volume of its bond purchases later in the year. On November 3, 2021, the Federal Open Market Committee unanimously voted to scale back its asset purchases. Indian equity markets remained volatile last week after Federal Reserve Chair Jerome Powell announced that the US central bank was ready to hike interest rates in March and balance sheet trimming would start soon after.

The survey said India’s salient external sector sustainability indicators are strong and much improved as compared to what they were during the global financial crisis or taper episode of 2013. “For instance, the import cover and foreign exchange reserves are more than double now. The combination of high foreign exchange reserves, sustained foreign direct investment, and rising export earnings will provide a good buffer against any liquidity tapering/monetary policy normalisation in 2022-23,” it added.

The Federal Reserve embarked on a programme of asset purchases under the Quantitative Easing (QE), as part of a broader policy response to the Global Financial Crisis in 2007-08. As the US economy gained traction, in an attempt to unwind the QE, on May 22, 2013, the Fed announced the intent to start tapering asset purchases at a future date, which triggered a tantrum in the form of spike in bond yields and resulted in disruptions on the external front for India as well.

The Survey said 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, reserve cover of imports have shown marked improvement in the first half of FY22 compared to the taper tantrum year FY14. Another key vulnerability indicator--net international investment position (IIP) to GDP ratio has declined to (-) 11.3 percent, as against (-) 18.2 percent in the said period. The external debt to GDP ratio has also declined since FY14. Besides, India witnessed a current account surplus of 0.9 per cent Q1 of 2021-22 on top of similar surplus in 2020-21 after a gap of 17 years. On the other hand, 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), the survey reasoned.  

The United Nations Department of Economic and Social Affairs (UNDESA) last month said India is in a better position to navigate financial turbulence due to Fed monetary tightening compared to its situation during the “taper tantrum” episode after the 2008-2009 global financial crisis even though it remains vulnerable,

“This is due to a stronger external position and measures to minimize risks to bank balance sheets. In the medium-term, scarring effects from higher public and private debt or permanent impacts on labour markets could reduce potential growth and prospects for poverty reduction (in South Asia),” UNDESA said in its "World Economic Situation and Prospects" report.

India’s external trade recovered strongly in FY22 after the pandemic-induced slump of the previous year, with strong capital flows into India and record exports, leading to a rapid accumulation of foreign exchange reserves. “However, the downside risks of global liquidity tightening and continued volatility of global commodity prices, high freight costs, coupled with the fresh resurgence of covid-19 with new variants may pose a challenge for India during FY23,” the survey cautioned.