India’s current account deficit is, according to Shaktikanta Das, eminently manageable. A narrowing merchandise trade gap, robust services exports and a turnaround in FDI are all contributing. Forex reserves have become stable after a patch of vulnerability during a spike in energy prices. India’s import cover is within the policy comfort zone. The rupee faces pressure to appreciate from remittances and capital inflows. Past experience would suggest RBI will utilise most of these favourable trends to shore up reserves while allowing the rupee to creep up within a policy band. This has been the hallmark of India’s exchange rate management since the start of economic reforms in 1991.
The approach, though, has a bearing on interest rate management. With inflation well on its course to its 4% target, a shrinking CAD could offer RBI more cushion over interest rates. The rate-hiking cycle has delivered the demand compression needed to tame core inflation without sacrificing growth too much. If the commodity cycle stays benign, RBI could consider easing its disinflationary stance earlier than anticipated. This will align with interest cuts central banks in advanced economies attempt later this year. The scope for synchronisation should lend greater stability to exchange rates.
India’s merchandise exports stand to gain from the twin prospects of lower interest rates and a stable rupee. The economy is pinning its growth hopes on manufacturing exports in a global realignment of supply chains. The next leg of growth will be driven by private investment that can be facilitated through low interest rates. Emerging relatively unscathed from a global economic crisis, India should push its advantage while energy prices remain soft.
