Bernanke’s decision to keep the stimulus does give economies such as India's the space to carry out reform

In a development that stunned not just the U.S. markets, the U.S. Federal Reserve sprang a big surprise by keeping its $85 billion a month asset purchase programme intact for at least a few more months. The ultrasoft monetary policy, designed to keep interest rates in the U.S. abnormally low to aid recovery in the post-recession period, would continue most probably at least until the end of the year.

The implication of this has not been lost on stock markets everywhere. Soon after the announcement, the U.S. benchmark index S&P was pushed up to record levels. New records were set by the hour in India and many other Asian markets which had ample time to react to the Fed announcement. On Thursday, the Sensex and the Nifty gained 685 points and 216 points respectively. The rupee, which has lost more than 11 per cent since May, benefited immensely gaining by nearly 2/ per cent against the dollar. The stock markets might be overreacting but the removal, albeit temporarily, of a fear of the U.S. stimulus programme being “tapered off” soon is seen as a huge positive. Since May, when Fed Chairman Ben Bernanke hinted at that possibility, the market sentiment in India and many developing countries were weighed down. In India, the rupee entered a sharp phase of depreciation which has threatened macroeconomic stability.

Although many other factors — the weak economy and the large current account deficit — were cited, the principal cause has been the flight of short-term capital flows back to the U.S., sensing the possibility of better returns there. Indeed, one of the principal reasons for the Fed going slow is its revised perception of the U.S. economy not being robust enough to dispense with the huge monetary stimulus. Recent employment data have also not been up to the mark and the Fed says it is worried over the possibility of a political impasse in the Congress. The Fed’s surprise action is designed solely for the U.S. economy but it does give hard-pressed developing economies such as India’s breathing space to carry out structural reform. The monetary policy review scheduled for Friday, the first by the new Reserve Bank of India Governor, Raghuram Rajan, is bound to look at a wider range of options than what seemed possible until now.

A reduction in the policy rates may not be on the cards yet — inflation has surged — but the tight money conditions imposed in mid-July to support the rupee might be loosened if not done away with altogether. It will be good to remember that the Fed action, while conferring temporary benefits, also exposes the dangerous dependence on short-term capital flows.

narasimhan.crl@thehindu.co.in

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