US Federal Reserve chairman Ben Bernanke’s comment on rolling back the monetary stimulus package couldn’t have come at a more inopportune time for the Indian economy.
The rupee has crashed to a new low, nearly touching 60 and still counting. As portfolio investors pull out funds, the slide in equity markets continues.
Blame it on QE3. It sounds like the name of a scientific project, but it is essentially a financial market jargon for the third round of quantiative easing or QE by the US central bank.
It involves a large purchase of bonds by the Fed to pump in loads of cheap money into the financial system to aid the American economy. Part of these funds came to emerging markets such as India that were still delivering returns in high double-digits a year.
The tide has since turned.
Financial investors have begun selling Indian stock since the beginning of May and with the curtains likely to come down on the US stimulus package, one can safely expect more billions to move out.
A weak rupee can also fan inflation by making fuel and other imported goods costlier. Oil companies fear that if the trend sustains for a few more days, retail prices of transport fuel would have to be hiked again, which can fan inflation.
Higher inflation will also limit the RBI’s ability to cut interest rates, dimming hopes of lower loan EMIs for individuals.
Also, the record current account deficit (CAD) may restrict the RBI’s elbow room to prop up the rupee by dipping into its $290 billion of foreign exchange reserves, enough to cover imports for seven months, analysts said.
“A reversal of capital inflows would likely wreak havoc on the rupee, as financing the CAD becomes difficult,” said Sonal Varma, economist at research firm Nomura.
“Return of foreign capital in the short term will critically depend on adopting the right policy mix to attract higher investment inflows and improve growth prospects of the economy,” said DK Joshi, chief economist, CRISIL Research.