Fed stimulus: India needs US crutch to stay standing

It is no wonder Americans look down upon the world, including India. The US Central Bank, the Federal Reserve (Fed) determines the state of the economies of countries from India to Indonesia to Brazil. It is not that the Fed believes it can make or break economies. The Fed’s primary aim is to address inflation and unemployment in the US and its policies are geared to that end. Unfortunately for the rest of the world, the Fed’s actions have a knock on effect globally as the dollar is the reserve currency of the world.

India at one point of time was touted as an economy driven by domestic consumption and would not be as affected by Fed’s actions as export driven economies or economies driven by capital flows. However, India as a stand out country, was proved completely wrong when the rupee tanked over 40 percent to record lows against the dollar on the back of fiscal and current account deficits and on the back of the Fed taking a call on withdrawing its asset purchase program.

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In fact India’s Prime Minister Manmohan Singh went to the recent G-20 summit in St. Petersburg and spoke about the fact that the Fed must carry out an orderly exit from unconventional monetary policies as it affects emerging economies such as India.

[caption id=“attachment_1120227” align=“alignleft” width=“380”]  India as a stand out country, was proved completely wrong when the rupee tanked over 40 percent to record lows against the dollar. Reuters[/caption]

It is high time that Indian policy makers realise that the best way to avoid knock on effects of Fed’s policies is to make the country stand on its own feet. The first and foremost issue plaguing the country is the current account deficit that is caused by oil imports that account for over 55% of the country’s trade deficit.

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Oil importing countries such as India that runs both fiscal and current account deficits must stop subsidizing fuel that accounts for around 1% of GDP. Oil subsidies exaggerate consumption, cloud inflation and impair monetary policy of the country.

Many chapters are written by economists on what are the right things that India should do to strengthen the economy including improving tax to GDP ratio, which is amongst the lowest in the world.

India can only get away from Fed’s or any other global central bank action by making sure that the economy is able to withstand large inflows and outflows of capital from the country. India has opened its doors to foreign capital with easing controls on flows into equity and debt and this policy is irreversible. Capital flows will come in and go out on the back of the global markets response to central bank actions.

A country with strong finances, right policies and a good foreign exchange reserve position can easily withstand external shocks. Fortunately domestic savings funds India’s deficit while its external debt to GDP ratio at around 21% of GDP is low by any standards. India, if it gets its act right can still stand on its own.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.