How the U.S. Fed’s tapering can affect Indian markets

December 5, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

It was never expected to be permanent. Quantitative Easing (QE), designed to pep up the U.S. economy after the financial crisis of 2008-09, has survived for five years. The United States is now on a rebound and unemployment is receding. That has tempted the U.S. Federal Reserve to reconsider tapering its economic stimulus.

This was first announced on May 17 and sent tremors through global markets. Asian markets were the most affected; India was worst-hit, having come to depend on FII investment. The knee-jerk reaction of FIIs was to reduce exposure to emerging market economies in the expectation that liquidity would dry up and interest rates would harden.

Between June and August, FIIs pulled out 230 billion rupees ($3.7 billion) from the stock market, dragging the Sensex down 2000 points or by 10 percent. The rupee was also hit, losing 27 percent in three months and the RBI was forced to take emergency measures to stop and reverse its fall.

But the actual tapering was never announced. Federal Reserve Chairman Ben Bernanke changed his mind because growth, by his reckoning, was too slow. Tapering was postponed although the intention to taper was not abandoned. It is still on the Federal Open Market Committee (FMOC) agenda that will be discussed on Dec. 17.

If the decision is to taper, possibly from January 2014, will world markets be shattered once again? Very unlikely.

The announcement in May was a shock. The markets have now come to expect that tapering is inevitable and will be initiated. The only uncertainty is about the date and the extent of tapering. Most markets have already factored in this possibility.

In India, steps have been taken by the RBI to make up for the outflow of FII investment that can follow. Besides, since September, the parameters that influence the markets for stocks and currency have perceptibly changed.

Exports have recovered and non-oil imports declined, resulting in a 20 percent reduction in trade deficit. Consequently, in the quarter ending September, the current account deficit dropped 76 percent to 1.2 percent, which, along with the $34 billion that the RBI mobilized, would give the rupee stability.

Also, FIIs themselves may not be motivated to take money back since the U.S. Fed, along with the Bank of Japan and the European Central Bank, is committed to maintaining low interest rates. Unlike the June-August period, the announcement of tapering may not induce a hot money outflow — if at all, the amount would be small. As such, markets will not be seriously rattled.

A supplementary source of liquidity will also come from the Bank of Japan’s quantitative easing at the rate of $47 billion a month. This is the crux of Abenomics and it will continue for at least two years.

It appears that tapering, even if it comes as early as January, will not have a significant impact on the stock and currency markets. It will be the domestic factors that will predominate.

 

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