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There was one “taper tantrum” that took place in 2013 when Quantitative Easing (QE) was tapered off by the US Federal Reserve to tighten the money supply in its economy. QE was done by the Federal Reserve to fight the financial crisis of 2008 to encourage lending and investments, to encourage consumers to continue spending and allow the money supply to circulate enough to keep the economy afloat.
How could tapering not affect emerging economies?
Bond prices fall in emerging markets (EMs) indicating higher bond yields that makes stock prices less lucrative.
Foreign investors get on selling spree from equities and bonds causing capital outflows sufficient enough to weaken the rupee in EMs. E.g. Value of rupee had dipped over 15% between May-Aug 2013 in India.
When the rupee falls, foreign investors stand to lose from their holdings leading to a possible pull out and foreign investors need to pay more to hedge against a rising foreign exchange risk.
It affects inflation in EMs. E.g. RBI had to raise interest rates to control capital outflows in 2013 in India.
Impact of Taper Tantrum 2013 on India?
With capital outflows, India’s fragility became more evident. Trade deficit widened to $136 bn in 2013- 14 from $6 bn in 1990-91.
Exchange rate depreciated sharply crossing Rs.60 a dollar in Aug’13 despite foreign exchange reserves of almost $20bn were used up to support the currency. India was on watch with a negative outlook.
Current account deficit (CAD) rose to 4.8% of GDP in 2012-13 largely due to increase in gold imports as there was high demand for gold as an asset induced by high inflation of 12.17% in that particular year.
In response, RBI had eased restrictions on foreign borrowing by companies and encouraged Indian banks to attract NRI deposits to mobilise currency. Customs duty was imposed on gold imports and fiscal deficit was reduced by cutting government plan expenditure. These actions brought rupee below Rs.60 to a dollar and CAD was narrowed to 1.7% in 2013-14. Forex were at almost $300bn that gave enough time to take corrective steps.
Again, we hear UD Fed announcing taper tantrum to withdraw the excess liquidity from its economy as it faces acute inflation of 8.5% with zero interest rates due to the quantitative easing done in the year 2020 to save people’s lives from the pandemic risk. The governments had spent exponentially prioritising on healthcare over growth. The economies across the world had announced several stimulus packages as a monetary measure to keep their consumption demand in place and stimulate the credit flow.
Inflation is one of the repercussions of QE and geopolitical tensions that countries are currently facing across the globe. The countries are therefore focussing on aggressive monetary tightening through rise in interest rates that is roiling emerging markets. Shortage of semi-conductor chips, crunched crude oil supplies by Russia, and consequent supply chain bottlenecks are pushing the food prices in an upward direction.
What is the impact on India?
RBI has raised interest rates to align with US Fed to ease its 6.95% inflation in India. The external factors is driving the inflation hence it is least responsive to domestic policy.
There has been consistent selling pressure from Oct’21 that continues even now, showing up huge FII outflows of $16.82 bn between Jan’22 to Apr’22. Trade deficit has ballooned to $20 bn in Apr’22 as against Rs. 15.29 bn in Apr’21.
Rupee has depreciated to Rs.77.53 a dollar due to heavy selling trend in Indian stock markets by foreign investors. Extreme rupee volatility would deter Indian imports, gradually erode foreign exchange reserves and widen its current account and trade deficits.
10 year Indian government bond yields have risen to 7.4% that is making government securities and debt markets more attractive to investors. Indian stock market could be seen in red for some time as the companies are moderating themselves to their expected valuations.
Various global factors like US Fed’s and RBI’s surging interest rates, persistent inflation, elevated crude oil and energy prices induced by the War and depreciating rupee is a cause of concern for Indian economy.
Nevertheless, India is presently in a better position to handle such exogenous forces because we have strong exports that have surged by 23.69% in Jan’22 at $34.06 bn. India has sufficient foreign exchange reserves at $597.73 bn as on May’22. There has been a remarkable rise of domestic investment in listed companies to 7.42% in Mar’22 from 6.12% in Mar’15 in India. Domestic investors have managed to keep the Indian economy afloat despite FII’s exit thereby instilling their confidence in credibility, market valuation and its growth story.
Disclaimer- Author’s opinions in the article are personal.
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