In an opinion piece for the Financial Times newspaper that is effectively addressed at his American equivalent, Reserve Bank of India Governor Urjit Patel has argued that the United States Federal Reserve should reduce the speed by which it trims its balance sheet, in the long-overdue winding down of additional balance sheet items taken on as part of the response to the financial crisis. Mr Patel points out that the shrinkage will peak in October of this year, and by December 2019 total $1 trillion. While praising the Fed for having responded in the past to macroeconomic signals determining the pace of its exit from extraordinary monetary policy, the RBI governor has pointed out that the Fed has not so far responded to another unusual action — the Trump administration’s tax cuts, which have greatly increased sovereign borrowing of the US government and thus have mopped up more dollars than what may have been expected when the Fed’s balance sheet wind-down was being planned. Mr Patel’s contention is that this unexpected “double whammy” has hit the dollar bond market, and thus has particularly impacted emerging markets which are now subject to large capital outflows.
The governor’s point is well argued, and it cannot be denied that stability of the dollar bond market should be a shared responsibility for the world’s central banks. Mr Patel will be able to point to a precedent in this respect, as his predecessor Raghuram Rajan had also argued in 2014 for greater global coordination on liquidity. Yet there is something odd about the governor’s making this argument. It is not just that most central bank governors do not comment in writing in this manner on their colleagues’ choices. It is also that the other actions by the RBI sit uncomfortably with Mr Patel’s argument. After all, the RBI itself has not acted enough to preserve stability in these markets. The traditional way in which this problem would have been approached is through building up reasonable foreign exchange reserves and then using them to manage the controlled fall of the rupee. Yet this procedure is not being followed. While the RBI has built up substantial reserves compared to the level during the “taper tantrum” of 2013, they are nevertheless much lower than their pre-crisis levels, when seen as a proportion of gross domestic product. As a recent Moody’s report pointed out, India’s debt as a proportion of its reserves is high when compared to its Asian peers (except Indonesia) and the problem is brought into stark relief if short-term debt to reserves is compared across time for India.
It is certainly true that the recent outflow of capital from India should have been taken note of by policymakers. Yet, it is important to note that the rupee is, by most reasonable estimates, seriously overvalued. The RBI may have lost the easiest opportunity to build up reserves, but it can at least accept that the global macroeconomic situation is such that emerging market currencies, including the rupee, will lose value. While this might impact importers and oil prices domestically, it will also have substantial benefits for exports, development and growth.