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10/14/2014

The Economic Times


Title : Turning Dollar Cycle is an Opportunity, Not a Challenge
Author : SRINIVAS VARADARAJAN Director, Deutsche Bank, India
Location :
Article Date : 10/01/2014
As widely anticipated, the RBI kept policy rates unchanged.Since the last policy in August, a few
developments have informed the RBI decision. Commodity pric es have fallen appreciably. Brent
crude has fallen by close to 15% in the last two months. There have been appreciable falls in global
iron ore, copper and coal prices as well. While the rupee has weakened against the dollar, it has
actually appreciated against the Euro, AUD and the JPY. Further, within Asia, the INR has
depreciated by less than 1% to the USD since August, which is at the lower end compared to its Asian
peers.
The policy strategy going forward would be to immunise India from the dollar cycle through excellent
fundamentals while benefitting from the dollar cycle's impact on commodity prices. The pieces are
falling into place
an in flation-targeting framework, fiscal consolidation and a healing current
account. A credible inflation-targeting framework will go a long way in assuring foreign investors of
long-term stability in the external sector. In fact, the global experience has been that countries that
have successfully implemented an inflation-targeting framework have witnessed buoyant asset
markets in equities and fixed income.
In the policy statement, it was indicated that the risks to the medium-term inflation objective of 6% by
January 2016 is still to the upside, warranting policy preparedness. Penciling in average inflation of
7% from January 2015 to January 2016, a negative output gap of 1%, the effects of a positive inflation
drift to target of 6% and the negative output gap nullify each other. Assuming a real policy rate of 1%,
rates should broadly remain unchanged to the 2016 horizon. A 1% real policy rate might be
appropriate with the economy disinflating and as banks reintermediate financial savings.The only
issue to contend here is that with still high and sticky inflation expectations, the expected real rate
might be higher. Therefore, it is paramount that inflation expectations come down as the economy
disinflates.
The other key requirement would be to build up domestic savings to enhance the economy's potential
output. Once again a credible inflation-targeting framework will help in augmenting domestic savings.
This is critically important to avoid an overheating chicane should the capex cycle pick up in right
earnest. A successful management of the process will surely be rewarded with a ratings upgrade down
the road.
To sum up, we should view the turning dollar cycle not as a challenge but an opportunity. The turning
dollar cycle probably cracks the decade-long super commodity cycle and should be a huge tailwind
for India. We should remain steadfast on the inflationtargeting framework. The current account
balance net of POL imports is in surplus
a positive development. The commodity tailwind should
only reinforce this process. Over time, we should be confident enough to remove the restrictions and
enhanced duties on gold imports. This development is still some time away. However this, coupled
with a softening of inflation and inflation expectations, could be the key marker towards a softer
policy regime.

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