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October 03, 2019

Indian Economy: Surfing a fresh wave of global easing

The world economy is afflicted by weak sentiment, trade-related disruptions, and rising downside risks to growth. Central banks leaning towards lower rates reflects growing pessimism on the growth front. For instance, the European Central Bank replaced forward guidance of monetary tightening in 2019 with resumption of quantitative easing and cut in deposit rates to -0.5%. The US also started easing this year after a phase of tightening and is expected to continue doing so.


Studies show that post financial shocks, the US monetary policy is the most important determinant of capital volatility. We saw that after the 2008 Global Financial Crisis.


While different central banks started normalizing at different points of time, the Fed’s normalization (which began in 2013) had the biggest impact globally.


It led to the infamous ‘taper tantrum’, which resulted in capital outflows, currency volatility, and changes in the monetary policies of the affected countries.


We find that the financial cycles and monetary policy actions, particularly from the US post 2008 crisis, had a significant impact on the Indian economy, too. Being a part of the ‘fragile five’ meant India also saw volatile capital flows and a plunging currency.


However, the extent of impact was determined by India’s own economic health – a factor that would hold true this time around, too.


Yet, some things are different now from the 2008 scenario.


While global monetary conditions are expected to ease, the environment is also in a state of flux. Given this, India must be wary of relying heavily on short-term capital, and instead, seize opportunities to attract more durable capital to aid growth.


The bright spot is that, despite a sharp downturn in gross domestic product (GDP) growth, other macroeconomic parameters are healthy, reducing India’s vulnerability to external shocks. So far, foreign direct investment flows have been healthy, though portfolio flows have witnessed high volatility.