Observed in 2013, and this year, tapering is the opposite of quantitative easing measures. The US Fed had adopted measures to tighten the money supply, leaving the financial markets within the US and worldwide in a state of disarray.
What is a taper tantrum?
During the 2008 financial crisis, quantitative easing (QE) measures were adopted by the US Fed. Under this, a large number of bonds and securities were purchased, leading to an increase in the money supply. In contrast, in 2013, the Fed tightened the money supply, by announcing a reduction in purchases of bonds and securities. This is called tapering (of the money supply), which results in taper tantrums.
It was observed once again this year, following the QE measures during the Covid-19 pandemic, and the Russia-Ukraine war. The US Fed had increased its interest rates by 75 basis points thrice. Reuters predicts a fourth-time increase in November, from the current interest rates of 3-3.25% to 3.75-4%. (Reuters, n.d.)
Implementation and implications of a taper tantrum
Central banks taper an economy’s money supply by increasing interest rates, as was done this year. As a result, loans become costlier, thereby reducing borrowing. higher interests also lead to overseas investments being ploughed back into the US.
Also, as was done in 2013, the purchase of government bonds can be curbed by the central banks, not necessarily increasing their sale. Hence, the money supply is again tightened, with an increased yield from bonds.
Though the 2013 tapering was inevitable after the QE measures of 2008, the uncertainty over its timing and pace disarrayed the US as well as global financial markets. Foreign Portfolio and Institutional Investors diverted their investments towards US securities. Forex reserves of the trading partners were affected, inflation of the trading partners surged, and their currency depreciated.
Impact in India
In 2013, foreign institutional investors pulled out money from both equities and bonds. The rupee had depreciated by 24% against the US dollar.
Now, as pointed out by Sunil Sangai, the founder and CEO of NovaaOne Capital, the rupee has depreciated moderately, and gradually, with inflation controlled and fiscal discipline ensured. How did it happen you ask? Here’s your answer:
India’s focus has shifted to enhancing the productivity of its economy, with increased digitization. For example: in less than a decade, 10% of total retail commerce has moved to e-commerce; artificial intelligence and telemedicine are expected and have improved the efficiency of agriculture and healthcare respectively; digitization in manufacturing has reduced machine stoppage by 30%, and labour productivity improved by 15%.
Fiscal discipline was ensured with inflation-targeting policies. Though our inflation level is beyond the threshold limit of 4+2%, the RBI has managed it well at 7.4%.
Corporates want to shift 20-30% (some in entirety) of their manufacturing out of China, and we are prepared to be that alternate destination, with schemes such as Make in India. Like many other countries, we were ready to position ourselves as China+1, but now, in some sectors, we are prepared to move to minus China.
Our start-up ecosystem has contributed its part to the economy. over 76,000 start-ups have created almost 1 million direct and much more indirect jobs, increasing efficiency, ease of doing business, and capital inflows.
Thus, despite the Fed increasing interest rates, India’s focus on fundamentals such as above, helps it stay resilient and as a strong investment destination, delivering better returns on investment. Compared to 2013, India is in a better position to endure taper tantrums. Further, being the 5th largest economy in the world, it has bargaining power with its trading partners, and successfully reflected it in its trade alliances, like BIMSTEC.
Sources
Taper Tantrum of 2013: What It Is and What Caused It https://www.investopedia.com/terms/t/taper-tantrum.asp
Fed to deliver another big rate hike as job market fails to cool https://www.reuters.com/markets/us/fed-deliver-another-big-rate-hike-job-market-fails-cool-2022-10-07/
Fed Tapering and Its Impact on the Markets Fed Tapering and Its Impact on the Markets (thebalancemoney.com)
Comments