India’s economy is far better prepared to withstand any sharp tightening of global markets akin to the “2013 taper tantrum” episode in the wake of the US Federal Reserve tightening monetary policy, the Economic Survey for 2021-22 said.
“The combination of high foreign exchange reserves, sustained foreign direct investment, and rising export earnings will provide an adequate buffer against possible global liquidity tapering in 2022-23,” the report said.
In its latest policy, the Fed indicated that it may hike interest rates as early as March, and global markets have begun to price in more than four rate hikes by the Fed in 2022. What’s more important is that the Fed may start reducing its balance sheet once it begins to hike rates. As such, the US central bank is expected to stop buying bonds completely. This has spooked foreign investors, enough for them to exit vulnerable emerging market economies, including India. Foreign institutional investors have pulled out $3.8 billion so far in 2022 from Indian equities.
References to the earlier episode of a sharp correction in global markets in 2013 when the Fed has tightened have been made. In that year, the Fed had indicated it would begin to reduce its quantitative easing as economies were emerging out of the global financial crisis of 2008. At that time, India was listed among the five most fragile economies to dollar outflows. Indeed, the Indian rupee depreciated by almost 15 percent between May and August in 2013 on the back of record dollar outflows. Domestic sovereign bond yields had surged to near double digits. India’s external sector was perilous due to a large short-term debt pile and modest forex reserves.
Fast forward to today, the Fed is back to tightening again and domestic equity indices have dropped sharply as well. Dollar outflows from domestic markets have begun and are expected to sustain. However, unlike in 2013 India’s foreign exchange reserves pile is at a record $634 billion. Its external debt ratios are benign. While sudden and sustained dollar outflows may hurt, it is unlikely to cause a lasting impact, the economic survey stated.
"India’s external sector – well supported by strong exports, capital inflows, low CAD and external financing requirements and high foreign exchange reserves, with various external vulnerability indicators well within manageable limits – is far better prepared this time to face any external shocks arising out of tightening of the monetary policy stance by the advanced economies in coming months," the survey said.
“The combination of high foreign exchange reserves, sustained foreign direct investment, and rising export earnings will provide a good buffer against any liquidity tapering/monetary policy normalisation in 2022-23,” it added.A bigger risk for India’s capital markets is inflation, both global and domestic.