Quantitative Easing

Indian economy: RBI’s foreign exchange reserves spare India from Fed action. This is what it means


India is expected to outperform its Brics peers if global markets sell lower in the next US Federal Reserve rate hikes, unlike the 2013 Fed cut. Pray, why? Because the Reserve Bank of India (RBI) under Shaktikanta Das has stored foreign exchange reserves, exploiting the advantage of the jump in global liquidity thanks to the easing of the central banks of the G3 (United States, EU, Japan) to counter the shock of Covid-19. Not surprisingly, the rupee has outperformed the Brazilian real and the Russian ruble since the pandemic.

The Fed has signaled a normalization of its policy, given high inflation, although rising Covid-19 cases pose a growth risk in the United States. It accelerates its reduction to end quantitative easing (QE) by March 2022. The Fed is expected to increase by 75 basis points (bps) in the second half of 2022 and by 50 bps in 2023, before stopping on a slowdown in growth. Some of the Fed’s projections are even more hawkish, however.

Inflation cools with oil

In response, the RBI will need to continue to normalize its monetary policy. It should block excess liquidity more aggressively. A saving grace is that the rise in the RBI’s cash reserve ratio (CRR) slowed the currency’s growth (M3) to 9.2% on December 3 from 12.3% last year. Its Monetary Policy Committee (MPC) can only monitor the resumption of the global interest rate cycle. Rate hikes of 25 bps in April, 100 bps in 2022-23 and 50 bps in 2023-24 are expected. The MPC will surely not want to maintain negative key rates for too long.

At the same time, consumer price index (CPI) inflation is expected to average 5.5% in 2022-2023, around the inflation estimate of the growth maximization threshold. of the RBI. Although CPI inflation is now accelerating with the base reversal, it is expected to peak in the next fiscal year with the slowdown in oil prices.

The tightening of the US Fed should not push the MPC to take risks with growth, given reasonable inflation. The CLSA India activity index signals a weak recovery. (On base effects, he forecasts growth of 9.5% in 2021-2022 and 8% in 2022-2023.) The Covid-19 epidemic began by hurting supply, with activity being blocked to prevent spread. It has now metamorphosed into a demand shock on lost jobs and income.

RBI’s Consumer Confidence Index remains below pre-Covid 19 levels. It cannot be overstated that flexible lending rates are the key to the recovery. The 10-year yield is expected to rise to around 7% by March 2022, as it anticipates the RBI’s rate hikes. Nonetheless, weak loan demand is expected to contain rising lending rates to, say, 25 basis points through September 2022. They have fallen 100 basis points since the pandemic.

A more rapid suction of excess liquidity will paradoxically slow down the rate tightening. After all, the high liquidity of the money market (of about two years of monetary reserve) will limit the RBI’s open market operations (OMOs) to buy government securities despite high budget deficits. RBI should step up efforts, lock in excess liquidity through longer-term reverse repurchases (up to 2 years from the current 15 days), further increase hold-to-maturity (HTM) limits banks and extend them until 2025, for example. 26 to allay fears of market impacts (MTM) related to rising yields and buy forward currencies to deflect the impact of the rupee.

Nirmala Sitharaman is expected to boost demand in Budget 2022 by further reducing petroleum taxes, reducing income tax for low-income groups and providing housing incentives through the Credit-Linked Subsidy Scheme (CLSS) . The GoI can easily create fiscal space by financing public investments through infrastructure bonds issued by the new National Bank for Infrastructure and Development Finance (NaBFID).

The greenback raises the red flag

When a bank subscribes to a government securities auction (g-sec), it must reduce its loan portfolio to transfer funds to the government account at the RBI. It crowds out the private sector. If the public is buying infrastructure bonds, all that happens is a transfer of funds from, say, an individual fixed deposit to NaBFID’s checking account. This has no impact on deposits, nor on liquidity, nor on foreclosure.

What if the dollar skyrocketed in anticipation of the US Fed’s hikes? The RBI is expected to allow levels of ₹ 77 / $ 1, if the dollar hits, say, $ 1.07 / ₹ 1 in mid-2022. He probably won’t want to waste valuable foreign exchange reserves on cross currency movements. After all, RBI now has the means to eliminate any speculative attack on the rupee, as foreign exchange reserves, at over $ 675 billion (₹ 51.33 lakh crore, including futures) exceed 600 billion. dollar (₹ 45.63 lakh crore) forex “adequate” reserve estimate.

In any case, the seasonality of trade also turns against the rupee from April to September, as summer and monsoons generally slow production and exports. The dollar’s strength is unlikely to continue as an anemic Fed bull cycle is envisioned.

What if stronger US growth leads to further Fed hikes? This actually supports the rupee as the risk will then increase portfolio flows to Brics countries like India. Overall, the Rupee is expected to trade broadly in a range of 73-76.50 yen / $ 1 in 2022-2023. The RBI will likely continue to buy currencies when the dollar weakens and will allow levels of ₹ 75 / $ 1 when it strengthens.

In short, Governor Das’ currency purchases triggered a virtuous circle for the rupee which will reduce the average annual depreciation to 2% against 5.2% in 2013-2020.