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The Indian economy is encountering major turbulence. As noted in my recent op-ed piece in the New York Times, "Why India's Economy is Stumbling," economic growth has decelerated from a peak of 11 percent to less than 4.5 percent today. Fiscal deficits, at an elevated 9 percent of GDP, have fueled inflation and worsening external imbalances. And India has found itself more integrated to world financial markets than before and more integrated than policymakers realized. As a result, external events—in this case, the likelihood that the US Federal Reserve will unwind its unconventional monetary policy—have led to capital flows and a decline of the rupee of over 20 percent against the dollar within a short space of time.
But India has suffered more than other emerging markets because of more shaky fundamentals. India's policymakers will have to respond boldly to be in control of the situation, not least because of three looming (exogenous) events.
First, the Fed's much-anticipated decision on the taper later this month (the Indian central bank has postponed its regular meeting to follow the Fed's Federal Open Market Committee (FOMC) meeting). Second, uncertainty in the Middle East has once again pushed up oil prices which will further worsen India's external balance because India is heavily dependent on imported oil. Finally, India's elections scheduled for later this year are promising to be unusually closely contested, which will heighten uncertainty and increase the pressures to spend to woo votes.
A more detailed diagnosis of India's ills and necessary policy responses can be found in the Times op-ed piece.
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