Tighter money will achieve most of these goals but for inflation, which could go either way.
As money gets tighter and rates creep up, the attraction of zero-risk US Treasury bonds will increase, compared to other assets. The glut of liquidity that has driven most equity markets to dizzy heights will run dry. India’s stock market, in the face of steadily falling company margins, very little productive investment and falling growth, has been driven by liquidity. With global liquidity set to fall, so will equities.
Another worry is the effect of tighter money on India’s external debt and the rupee. Between March 2016 and 2017, foreign debt fell 2.7 per cent, driven by a near-8 per cent fall in NRI borrowings as instruments matured. Corporate debt, which at 37 per cent is the largest component of foreign debt, also fell around 4 per cent in March. But a weaker rupee would raise the cost of servicing debt.
But the cost of Indian companies’ overseas borrowing costs will jump in rupee terms with a rise in US rates. Companies with falling margins have no appetite to invest for growth. With higher overseas interest cost, they will be in a bind if Indian banks, already saddled with bad loans, refuse to refinance foreign debt. The rupee will come under pressure, inflating import costs, but probably boosting exports. But India is a net importer and higher import costs are bound to pinch. This is the time for reform and Reserve Bank action.
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