The world’s largest economy has turned in a positive rate of quarterly growth, after four straight quarters of decline. The US economy’s 3.5% growth in the third quarter (July-September) is a big positive for global recovery, never mind that it rode on state-sponsored car and home sales that would not continue in the coming months.
However, an offsetting feature is the 21% jump in US exports in Q3, driven both by recovery elsewhere and the dollar’s weakening, which makes American goods cheaper in the importers’ currencies. But will the dollar now remain weak?
Perversely enough, rising economic confidence in the US is likely to result in further depreciation of the dollar. Restored confidence would reverse the flight to safety in the wake of the Lehman collapse in September 2008. The funds that had fled emerging and other markets to take refuge back home in the US in a bid to minimize uncertainty are now likely to retrace their steps back to markets where the returns are higher.
Just as the influx to safety had driven up the dollar, the funds’ redeployment across the globe would drive down the dollar. While restoration of economic health in the US would boost growth around the world and enlarge the market for India’s exports globally, oil prices would go up, too.
India must free up fuel prices. Since the dollar is likely to depreciate against most currencies, India’s export competitiveness is not the main problem. Export volumes would go up, export revenues at a more sedate pace. The bigger challenge, however, would be the resumption of capital inflows in excess of what the Indian economy can absorb.
As one of the fastest growing economies, India would get more than its fair share of investments, direct and portfolio, and that would drive up the rupee and boost valuations on the stock market. An appreciating rupee improves dollar returns on investment and induces further capital inflows.
To moderate the rupee’s rise, the RBI would buy up dollars and then sell government bonds to mop up the rupees created to purchase the dollars, so as to avoid inflation. The cost of holding down the rupee would, thus, be rising yields, as bond prices dip. The government has to start thinking now, whether it should follow Brazil’s example and impose restrictions on excessive capital inflows.
Source : ET