In 2013, the Fed Reserve had signalled that it would gradually roll back its bond-buying programme, popularly known as quantitative easing (QE), introduced to inject liquidity in the economy in the aftermath of the 2008 financial crisis. This decision by the Fed led to an increase in bond yields in the US. As a result, it triggered massive capital outflows from the emerging countries, including India, as investors shifted their money from riskier economies to safer advanced economies like the USA. This (over)reaction is referred to as the ‘taper tantrum’.
[You may also read: Quantitative easing explained & Financial crisis 2008 explained]
So what is taper tantrum-II?
Countries around the world introduced fiscal and monetary stimulus measures to tackle the coronavirus pandemic-induced recession.
The US reduced interest rates to zero and began buying assets (bonds and mortgage-backed securities) worth $120 billion per month in March 2020 to inject liquidity into the system.
However, in wake of the continued economic recovery in the US and rising inflationary concerns, the Fed announced that it would scale back the Quantitative Easing and raise interest rates.
The Fed began to taper its purchases in November 2021.
As per Goldman Sachs Research, the Fed is expected to raise rates by 25 basis points at each of its remaining meetings in 2022.
And, when the US sneezes, the world catches a cold
Should India be worried about taper tantrum-II, this time around?
The “fragile 5”- India, South Africa, Brazil, Indonesia, and Turkey- were the most vulnerable to the consequences of tapering in 2013.
India had a substantial current account deficit and therefore it was heavily dependent on foreign inflows for capital.
The fiscal deficit was also high.
Therefore, the announcement of tapering by the Fed triggered massive capital outflows, which, in turn, led to the depreciation of the rupee.
Foreign investors pulled out $10 billion in June-July 2013
Fast forward to 2022, India’s macro-economic fundamentals are stronger. India has accumulated record foreign exchange reserves on the back of capital account surplus. India’s current account deficit has also narrowed significantly.
Even during the pandemic, the country is committed to the roadmap for fiscal consolidation.
But, inflation, even though lower than 2013, has been rising in recent months.
Moreover, stock markets are overvalued and are due for a correction.
And, if the US bond yields surge, it will put pressure on RBI to raise interest rates to prevent capital outflows and depreciation of the rupee.
This monetary tightening could hurt the economic recovery.
All said it remains to be seen how tapering affects the economy. It is expected that taper tantrum-II might not be as bad as taper-tantrum-I, but India still remains vulnerable.
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But why does the Bond Yield increases when FED stops buying Bonds?
If Fed buys lesser bonds, it means demand for bonds will reduce which will lower its price.
Investors went into panic mode and started selling bonds in anticipation of the above. The supply of bonds increased, demand decreased. Hence, bond prices declined. Bond prices and yield are inversely related to each other.
Read: /bond-yield-meaning-explained/
Thanks