Taper Tantrum which was a buzzword in 2013 is back in news as the US Fed’s decision to hasten the process of the tapering program. Investors who have tracked the equity markets for some time now will be wary of the famous 2013 taper tantrum and consequent effects on the Indian economy. In this blog post, we will cover the immediate side-effects of US tapering on the Indian markets.
Table of Contents
What is US Fed’s Taper Tantrum?
Quantitative Easing
To understand the tapering program, we should first understand what it is Quantitative Easing. Quantitative Easing is a process by which the US Central Bank (Federal Reserve) or any other central bank of a country starts purchasing government bonds so as to pump liquidity into the system. The central bank does so to correct a struggling economy to spur up the demand in the economy. This happened in 2008-2013 in the US after the long recession affected the US economy. As part of the Quantitative Easing, lending rates will remain low, pumping more money into the market. In effect, the borrowers get easy money (money at very low-interest rates). But the lenders feel the pinch as they get back peanuts in return as interest for their lending. The borrowers who get easy money park their money by investing in equity markets of the emerging countries. This leads to lots of inflows into the emerging equity markets leading to a likely bullish run of the emerging equity markets.
Tapering:
The side-effects of Quantitative Easing are that since lots of money is being pumped into the economy, inflation will start rising. Everything is fine until the inflation is under manageable levels. However, sometimes it keeps rising beyond comfortable levels. It then becomes imperative for central banks to start tackling the rising inflation. This is what happened in the US in 2013. As Quantitative Easing started rising inflation in the economy, the US Fed started reversing its bond purchase program. This is known as Tapering.
Taper Tantrum
Tapering also means that the lower interest rates regime would soon see a reversal with interest rate hikes. Rising interest rates mean that the investors get a better return on their investment in the US. This will lead to the Foreign Portfolio Investors (FPIs) reversing their inflows to the emerging markets to invest in the US. In 2013, the US tapering triggered a lot of US investors to withdrew their money from emerging markets like India. This led to what is popularly known as Taper Tantrum. Taper Tantrum means the US dollar gains strength vis-a-vis the Indian rupee. A weak Indian rupee means the shelling of more money for buying crude oil. Thus, in turn, depletes the Forex reserves that India stores.
Tapering in 2021-22
The US Federal Reserve has decided to accelerate the process of reducing its monthly $120 monthly bond purchases program started in response to the Coronal virus pandemic. As per the new schedule, the tapering program will likely conclude by March 2022. This has caused quite a bit of negative sentiment in the Indian equity markets.
Effect of Tapering on Stock Markets in India:
Usually, US Tapering is associated with a lot of FPI outflows from India. This normally leads to a drag down in the Indian markets. However, in 2013, the effect of US tapering on Indian markets was not felt as much as it was feared. The markets did fall but recovered in no time. In fact, markets remained in a bullish phase starting 2014 till 2017.
Outlook in 2022?
There is no reason to think that the US Tapering will pull down the markets to a large extent in 2022 either. Yes, FPI outflows have been a regular story since October 2021. This has definitely put pressure on the Indian stock markets which are already in the overheated zone as per valuations. We expect the short-term weakness due to US Fed’s Tapering program but we feel it may not be the indicator that will decide the next course of action for the equity markets in India.
Rising inflation, fear of Omicron, rising interest rates are clearly the near-term hurdles for the Indian stock market. What do you think? Let us know.