It seems that the government has lost control over the rupee. The rupee is the worst performer among the EMEs ever since May 22, when Mr.Bernanke announced the reduction of Fed’s bond purchase programme.
The current programme of tapering just is the beginning of reducing the Fed’s bond purchase programme. So far, the Fed is slowing the purchase of bonds. Once it starts selling the accumulated bonds, dollar will fly back from the financial markets to the Fed’s vault. In the coming months, especially in early 2014, the Fed should start selling the purchased bonds. Here, the impact will be much more painful. There will be severe shortage of dollar and global liquidity may dry up.
The global liquidity cycle will be reversed and globally there will be a shortage of liquidity. In this case, current account deficit countries like India may undergo a free fall in the value of their currency.
India is the most credible currency crisis candidate. The country is the third largest trade deficit country in the world after the US and UK. France comes at the fourth position. Interestingly India is the only emerging market economy among the top eight trade deficit countries and this shows the depth of the country’s balance of payment problem.
Historically India was used to utilize foreign currencies coming from foreign investment channel to finance its current account deficit since the beginning of reforms in 1991. Now, with global liquidity (which is usually measured in terms of dollar supply from the US easy money policies) shrinking, foreign investment is difficult to come. At the same time, the India growth story is faded and may not attract capital again. We have lost many years to consolidate the early gains into sustainable progress because of political policy jigjam.
Adding to the woes, in the coming quarters, the country should repay the corporate debt it has acquired in the past.
With ballooning dollar payment obligations and limited reserves, India definitely doesn’t have the arsenal to fight the collapse of the Rupee.