Dealing with US taper would be a lot easier if India was part of a global bond index, just like it is for equities
Even if the US recovery seems patchy at times, the overall improvement is steady enough to make it a near certainty the Fed will begin its taper soon, though we will know for certain over the next few days when the Fed meets. From minus 2.7% in Q1 2008, that is well before Lehman, US GDP grew 2.5% in Q2 2013; from 10.1% in 2009 as a result of the need to stimulate a collapsing economy, US fiscal deficits are likely to be down to 4.6% of GDP this year and are projected to fall further to 3.4% in 2014; employment, which contracted by 350,000 jobs in May 2009, has been growing steadily at around 165,000 new jobs per month for the last 3 quarters.
While US interest rates have already started rising in anticipation of the taper, how much they will rise will depend upon the Fed’s projected GDP rates for 2015 and 2016. Which means the rupee is likely to be quite volatile over the next few days. The extent of the volatility will be determined by how much money flows out, and that, in turn, will be determined by the market’s perception of how much US interest rates, currently 2.78% for 10-year paper, will rise over the next year—a 50-75 bps rise is likely in the next 6 months.
The latest PMEAC forecasts, in this connection, are interesting. Unlike the finance ministry, the PMEAC view is that even if the CAD is contained at the $70 billion the finance minister has projected for FY14, India will still have a shortage of $8.6 billion on the inflows side, necessitating a drawdown of reserves by this amount. This, though, could turn out to be an under-estimate since, if there are FII withdrawals, the situation will be very different.
Between May 22 when the Fed first began talking of a taper, and now, $10.41 billion has flown out of debt investments made by FIIs; given that FIIs still have $10.6 billion invested in Indian debt, there is a chance a part of this could also flow out.
What’s interesting, however, is that in contrast to debt money, just $1.6 billion flowed out in terms of FII money in equity since May 22—that’s a very small fraction of the $145 billion