What a difference a year can make. Exactly a year ago, the world economy appeared to be on the verge of collapse as confidence was battered and economic activity came to a standstill. No economy was spared, as the crisis had been preceded by a global boom that had lifted economies across the board. The five-year party was brought to an abrupt end, putting pressure on the world. At that time, the key was to assure the markets that a floor to this sharp plunge would be defined. A piecemeal approach wasn’t the answer, as no one was sure which grain in the sand pile could cause further collapse.

Regulators across the world responded accordingly. The high point on cross-border coordination by global policy makers was on October 8, 2008, when for the first time, six central banks slashed their policy rates. Governments from China to the US announced huge fiscal expenditures, while massive rate cuts were announced in India and the Euro area. Since lack of liquidity was at the heart of most of the problems, the US Federal Reserve introduced or expanded dollar swap lines with various economies to avoid a collapse, and a trickle down on the world. Regulators adopted extreme measures like quantitative easing or printing money to soothe the markets. Given the global reach of these measures, G20 summits assumed greater significance. The holistic approach taken by the regulators yielded the desired results, and there has been a continuous improvement in economic data since the second quarter of 2009.

Within Asia, South Korea is likely to be the torch bearer. As for India, expect a more gradual stance and a balanced approach to an exit.

However, with a major collapse having been averted and the strength of the expected recovery varying among economies, the common global incentive to adopt growth-supportive policies is fading. Indeed, the divergence in problems facing developed and developing economies is becoming more evident with each passing day. While the US, UK and EU continue to grapple with growth-related concerns, Asian economies are already witnessing early signs of inflation risks.

An accommodative policy stance, copious capital inflows, unsterilised intervention in the foreign exchange markets and a pick up in commodity prices have the potential to stoke inflation in Asia. Hence, inflation will bottom out sooner in Asian and some other economies (indeed, it already has) than in the major ones. What this means is that unlike the policy stimulus of last year, exit strategies won’t be a coordinated affair. Weak consumption in the major economies, especially in the US, will force the authorities to announce another set of stimulus measures. In contrast, Asian economies should experience an end to fiscal stimulus and hikes from early-2010, following in the footsteps of Australia.

Within Asia, South Korea is likely to be the torch bearer, with India adopting a more gradual stance. Though inflation risks in India lie on the upside as well, one cannot ignore that the country experienced the worst drought in 40 years in 2009. Also, India’s inflation is more supply-led than demand-led. Hence, premature tightening of monetary conditions could adversely impact the smooth flow of credit to the public and private sectors in India and also result in asset-market volatility.

While the Reserve Bank of India (RBI) will continue to demonstrate its willingness to act proactively, initial steps towards an exit strategy are likely to be limited to withdrawing some of the stimulus provided in the form of lower provisioning requirements and downward revision of risk weights on banks’ exposure to certain sectors. Cash management bills could be an option to drain some of the excess liquidity temporarily.

Fresh issuance of market stabilisation scheme (MSS) securities when the RBI is still continuing with open-market operations (OMOs) might be counterproductive, and OMOs are unlikely to be done away with when there is upward pressure on yields. Hiking the cash reserve ratio (CRR) at this stage would perhaps be a strong signal, and the RBI could wait for a more appropriate time to hike the CRR without compromising its credibility. Any hikes in the repo and reverse-repo rates are likely only in mid-2010.

The Indian asset market should benefit from India’s early exit strategy, as compared to most developed economies. The balanced approach of the RBI will be the key to preserve investor confidence and sustain flows into India. Rates may inch up gradually as the RBI begins to implement its tools. Improved carry and attractive fundamentals may attract more capital flows into India, which should keep the appreciation pressure on the Indian rupee intact for a target of Rs 45 to a dollar in the next few months.

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MD & Head, global markets, South asia, Standard Chartered Bank