The risk of another taper tantrum remains. But India is relatively safe – The Economic Times

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India should not be over-worried. In 2013, it was highly vulnerable and was listed among the ‘fragile five’ EMs, along with Turkey, South Africa, Brazil and Indonesia. But today, India looks strong and resilient. It could be called one of the ‘formidable five’.

Commodity prices, global inflation and interest rates are rising. Central banks sound relaxed about this. Yet, they cannot ignore it. Their easy money policies since the 2008 crash, and even easier money to combat Covid-19, will surely be reversed in the next 12 months. This could mean a sudden change of mood and sharp global interest rate hikes, causing trillions of hot money to cascade out of emerging markets (EMs). Raghuram Rajan has warned of a possible repeat of the ‘taper tantrum’ of 2013.

India should not be over-worried. In 2013, it was highly vulnerable and was listed among the ‘fragile five’ EMs, along with Turkey, South Africa, Brazil and Indonesia. But today, India looks strong and resilient. It could be called one of the ‘formidable five’.

Qualitative Easing?
In summer 2013, the US Fed unexpectedly announced its intention to taper its huge quantitative easing (purchase of securities). This implied rising interest rates and end to easy money. Earlier, easy money and low interest rates had sent billions of dollars seeking higher returns to relatively risky EMs like India. The prospect of a Fed policy reversal caused a‘taper tantrum’, a panicky mass exit of a trillion dollars out of EMs.

India was among the worst hit. The Sensex crashed and its exchange rate went from Rs 55 to Rs 65 per dollar. Fears arose of a repeat of the 1997-99 Asian financial crisis that devastated India and other developing countries. However, the taper tantrum lasted barely two quarters, and global money began flowing back to EMs. In India, the credit for recovery was widely given to a non-resident Indian (NRI) deposit scheme by Rajan. But since all EMs recovered, clearly greater global changes were at work.

The unexpected, but unprecedented, economic boom of the 2000s had lifted all EMs, which had been in dire straits in the earlier two decades. Learning from the Asian financial crisis, all EMs had abandoned informal pegs to the dollar, ensured currency flexibility and built up their forex reserves to cope with future shocks.

The booming 2000s made EMs look stronger, safer investments. China, rather than the US, became the global locomotive pulling forward the world economy. Indeed, the yuan has now become a global reserve currency recognised by the International Monetary Fund (IMF). Global financiers have gained the confidence to advance beyond EMs to ‘frontier markets’ (like Bangladesh and Nigeria), whose stock markets earlier could not attract a single dollar. Many EMs today are no longer viewed as highly risky.

Another major change has been central bank attitudes towards public debt. In 2008, Carmen M Reinhart and Kenneth S Rogoff declared in their paper, ‘The Forgotten History of Domestic Debt’ (, with much academic support, that debt/GDP ratios above 80% risked economic collapse. Such notions have disappeared. The US ratio is about to cross 100%, and Japan’s has crossed 260%, with no ill effects.

Many politicians and economists now spout modern monetary theory, which says governments can borrow limitlessly in their own currency without causing high inflation.

Across the world, central banks have printed currency worth trillions of dollars without causing inflation. So, financial markets no longer panic at rising debt/GDP ratios. Interest rates have fallen so low — negative in Germany and Sweden — that the cost of servicing debt has crashed. This has happened to a lesser extent in EMs too.

Policy Poser
India’s repo rate is down to 4% from a peak of 9% in 2008. In 2013, India’s current account deficit (CAD) had soared to 4.9% of GDP. It is now close to zero and, in some months, India has run a current account surplus. Foreign exchange reserves were around $250 billion in 2013, but today are near $600 billion. So, even if $100 billion suddenly flows out in panic, the reserves provide a comfortable cushion.

Inflation was over 10% in 2013, but is now 4.3%. The price of oil has risen from $60 a barrel to $70 a barrel since early 2020. But it is still way low the $110 a barrel of 2013.

India’s one weak point is the fiscal deficit, budgeted at 4.6% of GDP this year, as high as in 2013. A huge Covidinduced fiscal deficit last year has pushed the debt/GDP ratio close to 90%. But nominal GDP growth should be 13-14% this year, so the debt/GDP ratio should fall. With interest rates plummeting since 2013, the cost of servicing debt has moderated considerably.

IMF seems likely to get board approval for issuing another $650 billion of special drawing rights, which are equivalent to convertible currency. This sum will be distributed in proportion to the quota of IMF members, so EMs will get only a small slice. Still, every little bit helps.

The 2013 tantrum made central banks aware of the importance of clear messaging, giving advance notice of future changes in monetary policy to avoid market panics. In the future, central banks will ensure that financial markets are warned well in advance of policy shifts, reducing chances of panicky capital outflows.

The risk of another tantrum remains significant. But India is well placed to survive with limited damage.

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