India should prepare a plan to respond to volatility in global currency markets that may come as the U.S. Federal Reserve reduces monetary stimulus, the International Monetary Fund staff said in a report.
While India’s finances have improved since last year, a coordinated plan is needed in case capital account pressures re-emerge, the IMF said. Any plan should make rupee flexibility the key defense and include measures to raise the benchmark interest rate, impose cash curbs, open foreign-exchange swap windows and raise diesel prices, it said in an annual review of India’s economy.
“The principal risk facing India is the inward spillover from a tightening of global liquidity interacting with domestic vulnerabilities,” the IMF said in the statement. Pressures associated with India’s “still-significant external financing need” could lead to higher borrowing costs, fund outflows and “disorderly adjustments” in the exchange rate, it said.
India has reduced its current-account deficit, increased interest rates and built up foreign-exchange reserves after the rupee plunged last year on news the Fed would curtail its $85 billion in monthly bond purchases. The rupee has gained about 11 percent since hitting a record low last August, the best performance among major emerging-market currencies.