EXPLAINED | The 2013 Taper Tantrum and why its spectre is being raised again

In 2013, as the world was coming out of a global financial crisis, the United States Federal Reserve said it would gradually reduce quantitative easing instituted after the Lehman Brothers bankruptcy in 2008. This would involve slowing the purchase of treasury bonds and hence reducing the money being pumped into the US economy.

March 26, 2021 / 10:36 PM IST
Ben Bernanke is a former Federal Reserve chairman, serving from 2006-2014. (Image: Reuters)

Ben Bernanke is a former Federal Reserve chairman, serving from 2006-2014. (Image: Reuters)

The phrase ‘taper tantrum’ has made a comeback in popular economic lexicon after more than seven years. A recent report by the Financial Times says that inflation and taper tantrum have replaced COVID-19 as the biggest worry for global investors. Even top Indian policymakers have commented on it. Finance Minister Nirmala Sitharaman said in both houses of Parliament during the Finance Bill debate that India faces no risk from a repeat of ‘taper tantrum’.

But what exactly was the taper tantrum?

In 2013, as the world was coming out of a global financial crisis, the United States Federal Reserve said it would gradually reduce quantitative easing instituted after the Lehman Brothers bankruptcy in 2008. This would involve slowing the purchase of treasury bonds and hence reducing the money being pumped into the US economy.

Before this, from 2008 to 2013, the Fed had tripled the size of its balance sheet from around $1 trillion to around $3 trillion by purchasing almost $2 trillion in Treasury bonds and other financial assets to prop up the market. Investors had come to depend on ongoing massive Fed support for asset prices through its ongoing purchases.

The announcement of reducing bond purchases by the then chairman Ben Bernanke was not received well by investors who responded immediately to the prospect of future decline in bond prices by selling bonds, depressing the price of bonds as a result, and shooting up the yields.

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How did it affect India and the world?

It wasn’t only US bond investors. The Fed’s actions caused a panic over rising credit costs across the globe as investors pulled their money, leading to sharp outflow from emerging markets, including Asia's, and forced central banks to hike interest rates.

India being one of the economies with huge capital inflows, as the money was pulled out by foreign portfolio investors, the rupee fell by over 15 percent between late-May and late-August 2013. This forced the Reserve Bank of India to raise interest rates to try and stem the outflow.

This didn’t really work at the time.

This correspondent remembers the then brain trust of Finance Minister P Chidambaram, RBI Governor D Subbarao, Finance Secretary Arvind Mayaram and Chief Economic Advisor Raghuram Rajan being closeted for hours in Chidambaram’s office. No announcement they made was enough to stem the fall of the currency.

While the taper tantrum was not the UPA government’s fault, it did in some ways add to the whole perception of economic mismanagement, in what were the last days of the Manmohan Singh administration.

Finally, when Rajan became the RBI Governor in September of that year, he announced the FCNR(B) window to encourage deposits by non-resident Indians. This eventually led to inflows of around $30 billion and helped prop up the rupee.

Rajan later admitted that he never supported deploying the FCNR(B) window. “Now I get credit for the idea which actually I neither invented nor actually believed in,” he had said in 2016, adding that the idea came from bankers.

Why are we talking about taper tantrum again?

 As the global economy flat-lined due to the COVID-19 pandemic, central banks and governments pumped in money into their economies through various stimulus measures.

But as economies recover, there are concerns of central banks turning off the proverbial tap and a subsequent rise in inflation. The real worry is that the Fed, which increased bond purchases will have to take the brakes of quantitative easing once again and raise interest rates.

Ratings agency S&P had said earlier this month that while emerging economies in Asia are better prepared than before to deal with a taper tantrum like incident, countries like India and the Philippines still stand the most vulnerable at the current juncture.

“Both economies have seen inflation rise in recent months. Real policy rates are below long-run average levels, eroding the return buffers. Capital may be quicker to leave and the central banks may have to respond by raising policy rates,” the rating agency said. However, it noted, "one mitigating factor for both countries is that current accounts are stronger relative to normal levels."

The RBI has lowered policy rates by 250 basis points since January 2019, of which 115 basis points were done after the nation went into a lockdown due to the pandemic. Given the weak economic recovery, analysts expect the rates to remain soft at least in the current year.

However, other analysts like DK Joshi of Crisil, have told Moneycontrol that central banks the world over will be more careful in withdrawing stimulus compared to 2013. There is also the matter of India being much more comfortable on the foreign exchange front.

As against $275 billion in forex reserves in August 2013, India’s forex currently stands at $582.27 billion. Hence the confidence among policymakers that the economy stands a better chance of dealing with a taper tantrum like situation.
Arup Roychoudhury
first published: Mar 26, 2021 10:36 pm

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