Fitch says India’s fiscal policy changes to help cope with tapering

fitchThe recent monetary and fiscal policy tightening in India is likely to help India and Indonesia cope better with the impact of the upcoming withdrawal of the US Federal Reserve’s stimulus program, ratings agency Fitch said.

India and Indonesia had seen their currencies swoon last year after commentary from the US indicated the Federal Reserve would soon start winding down the 85-billion per month bond purchase program. Most of the money pumped by the US Fed to stimulate the local economy has been making its way into emerging markets like India and Indonesia where it has inflated property, stock market and other asset prices.

“Two of the sovereigns that came under the most pressure over summer 2013 — India and Indonesia – have put in place policy adjustments that reinforce confidence in their fundamental economic stability and support the ratings at „BBB-‟/Stable in each case,” Fitch said on Thursday.

“Policy management is an important buffer for regional economies and sovereign credits against potential market volatility as the Fed begins “tapering” asset purchases under its quantitative easing programme,” it added.

The Indian government had announced measures to curb fiscal deficit, promote growth and attract investments after the currency plunged from 45 against the dollar to 68 last year. The rupee is currently at 62 to the dollar.

It said investors should watch for a “coherent, credible policy management – including willingness to accept a temporary slowdown in
in the interests of broader sustainability” in countries such as Indonesia and India.

Indonesia continues to rank as the most highly foreign exchange stressed emerging economy in Asia. Indonesia’s foreign reserves have depleted 40% in 2013 (see chart).

The second highest depletion was in India and Thailand at 15%, followed by Malaysia at 10% and Philippines at 8%. China’s forex reserves rose during the year by about 17.5%.

“The chart captures only a part of the story, as the contrasting cases of India and Thailand show. India‟s rupee recovered 10% against the US dollar between end-August and end-2013, while reserves rose 5.7%, as markets digested monetary and fiscal policy tightening in that country,” Fitch said.

It warned that loose fiscal and monetary policy settings run the risk of allowing demand to outstrip supply, putting pressure on inflation and the trade deficit when tapering starts in full swing later this year.

“Rising external funding requirements can in turn undermine investor confidence in an economy‟s fundamentals,” it said.

Fitch thinks fundamental strengthening in most Asian sovereigns‟ credit profiles since the 2008 Asian financial crisis is an important buffer for regional sovereigns against tapering-induced market stresses, it said.

Seven of nine emerging Asian sovereigns are on a stable outlook.

“So far, tapering-induced market stresses have had a limited impact on sovereign credit profiles.”