The 'no taper' decision of the US Federal Reserve has led to a spike in oil and gold prices, which will start to impinge on both the import bill and inflation. Policymakers may be lulled into a sense of complacency and slow the reform momentum, warns Nomura Asia Insights in its research note
The US Federal Reserve's decision to not taper asset purchases at its 17-18 September FOMC (Federal Reserve's open market committee) meeting should be positive for Asia's current account deficit countries in the near term. It will come as a big respite to Indian policy makers, who have been battling the currency since taper-talk started in May, says Nomura Asia Insights in its research note. A resurgence of flows into emerging markets could provide India with some breathing room, as balance of payment pressures ease, and allow the RBI (Reserve Bank of India) to start to gradually reverse its recent liquidity tightening measures.
Nomura forecasts that at its 20 September policy meeting, RBI will keep all policy rates (repo, CRR) unchanged, in line with consensus; sound hawkish on near-term inflation risks due to supply shocks (emanating from food and INR); and start a calibrated reversal of recent liquidity tightening measures. This includes: a reduction in the CRR balance requirement for banks, currently at 99%; an increase in net borrowing by banks to 1% from 0.5% of net demand and time liabilities under the liquidity adjustment facility; and a 50-100bp cut in the marginal standing facility rate (from the current 10.25%).
However, Nomura analysts hasten to caution that the 'no taper' decision has led to a spike in oil and gold prices, which will start to impinge on both the import bill and inflation. Policymakers may be lulled into a sense of complacency and slow the reform momentum. Additionally, if the currency starts to appreciate, imports will become cheaper again, and in the absence of a domestic supply response, this would result in imports starting to substitute domestic production. Therefore, we expect India's current account deficit to start to widen again and imported inflation (through higher commodity prices) to rise.
If the caution is not observed by the government, India's macro imbalances should start to worsen again and the fundamentals (weak growth and sticky inflation) remain bad. Therefore, Nomura’s negative outlook on a six-month horizon remains unchanged from previous research notes.
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