Fed Reserve policies may cause market volatility. RBI must be watchful

Clipped from: https://indianexpress.com/article/opinion/editorials/managing-tantrum-us-economy-us-federal-reserve-open-market-7365444/

RBI needs to be watchful of implications of withdrawal of accommodative policies by the US central bank

This expected pivot will also have implications for the bond buying programme.

In its recent meeting, as was expected, the US Federal Reserve’s Open Market Committee (FOMC) kept its benchmark policy rate unchanged, while maintaining the pace of its monthly asset purchases. But with the economic recovery in the US gaining traction — according to the IMF’s world economic outlook, the US economy is now expected to grow at 6.4 per cent in 2021, up from its earlier assessment of 5.1 per cent — and with inflation firming up, the signals emanating from the meeting suggest that it is now likely to raise rates earlier than was previously estimated. The dot plot — which shows the interest rate predictions of members of the FOMC — now signals two rate hikes by the end of 2023, bringing forward the date of the policy pivot. Thirteen of the 18 members on the committee are in favour of rate hikes in 2023, while seven members expect a hike in 2022. This expected pivot will also have implications for the bond buying programme. So far the US Fed has given no indication of when it will begin to slow down its asset purchase programme. But with Jerome Powell, chairman of the Federal Reserve, acknowledging that the issue was also discussed, these signals are likely to raise fears among central banks of emerging economies of history repeating itself.

In 2013, mere talk from Ben Bernanke, the then chairman of the US Federal Reserve, that the Fed would begin to “taper” its asset purchases, caused mayhem across financial markets in emerging economies — an episode known as “Taper Tantrum”. Capital began to flow out, bond yields rose and currencies collapsed. The situation was particularly grim for the “fragile five” — Brazil, India, Indonesia, South Africa, and Turkey — all of whom were then facing a toxic combination of large current account and fiscal deficits. India’s currency fell by double digits. This time around too, the impact of the FOMC meeting was immediately felt. Currencies of most developing economies in Asia fell against the dollar on suggestions of a sooner than expected policy pivot.

An eventual rollback of accommodative policies by the Fed may well cause market volatility. But it is likely that this time around, having internalised the fallout of the 2013 episode, communication from the Fed will be better. Clear communication of its objectives and timelines can help reduce market volatility. Markets are also likely to be better prepared this time. Further, most emerging economies also have considerably higher levels of foreign exchange. India’s foreign exchange reserves have crossed $600 billion — a cushion against such market volatility. However, such periods of uncertainty do complicate matters for central banks. In 2013, the Reserve Bank of India responded to the crisis through a mix of policy measures, including forex market intervention and monetary tightening. As an inflation targeting central bank now, while it will need to be watchful of the fallout of such policy changes, it will also have to carefully navigate this challenging terrain.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s