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Business News/ Opinion / Online Views/  Now look at global monetary risks
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Now look at global monetary risks

There is still a case for monetary easing in India. The only warning is that rate cuts may be far less dramatic than many are hoping for

Illustration: Jayachandran/Mint (Jayachandran/Mint )Premium
Illustration: Jayachandran/Mint
(Jayachandran/Mint )

Last week, most attention in India was focused on a series of domestic policy events: the report of the 14th Finance Commission that recommended a radical restructuring of fiscal federalism; the railway budget that for the first time in several years was rooted in a proper strategic vision; the Economic Survey that laid out a reform path for the Indian economy; and the budget that was widely acclaimed.

Such a flurry of domestic action quite naturally dominated the news. One consequence of this is that two crucial global monetary policy developments from the US and China were completely ignored. And there is one coming up this week in Europe. These will have a significant effect on the Indian economy in the coming months. They will also be part of the backdrop against which Reserve Bank of India governor Raghuram Rajan will have to decide his next move.

First, US Federal Reserve chairwoman Janet Yellen hinted last week that she will drop a key word from the guidance to be released this month: patient. It was there in her recent guidance statements. The opaque world of central banking often hinges around such lexicological nuances. Yellen seems to be telling the financial markets to prepare for a hardening of US interest rates, perhaps to avoid the sort of volatility that Ben Bernanke unleashed in May 2013, after his sudden statement that quantitative easing would soon be wound down. The true normalization of US interest rates could take several years, but even a modest retreat away from the zero bound could unsettle global capital flows.

Second, the People’s Bank of China announced a surprise rate cut on Saturday. This could be the start of another easing cycle in response to weakening economic growth as well as low inflation. Many economists also expect the Chinese government to go in for another round of stimulus by funding large infrastructure projects. These policy responses come with massive risks since China is now battling structural problems, rather than a cyclical downturn that can be managed through lower interest rates and higher deficits. India needs to watch whether the Chinese stimulus will once again push up global commodity prices, especially crude oil. After all, the recent decline in inflation owes a lot to the decline in global crude oil prices. Even a modest uptick in these prices could upset monetary and fiscal calculations.

Third, the European Central Bank is likely to unveil the details of its proposed quantitative easing later this week. And the actual monetary expansion is expected to begin later in the month. The euro has already fallen to its lowest level in 12 years against the dollar. The European policy landscape is also living in the shadow of the Greek problem, of whether there can be a debt settlement that satisfies both borrowers and lenders, and more specifically Greek and German voters. The extent of European quantitative easing will thus be crucial.

The US seems to be headed towards overdue monetary tightening while China and Europe are clearly in an expansionary mode. It is against this backdrop that Rajan has to make his next move. The Chinese monetary easing could upset his inflation calculations. New money printed in Europe could spill over into countries such as India that have higher bond yields. Tighter US monetary policy could pull money back into that country. It is a complicated situation, which is why the way the Indian central bank has assiduously built reserves as insurance against a global shock is welcome.

Add to that the fact that the budget announced last week is more expansionist than expected. There is still a compelling case for continued monetary easing in India. The only warning is that rate cuts this year may be far less dramatic than many in the financial markets are hoping for.

Fiscal expansion and monetary easing: can the tango work? Tell us at views@livemint.com

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Published: 02 Mar 2015, 04:26 PM IST
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