Acting too late? The shadow of the taper tantrum

The crisis in the mini-external sector in May 2013 is still fresh in our memory after the Federal Reserve’s tapped remarks. The push examines policymakers’ nerves and refutes two popular myths: one, the Indian economy has made significant resilience since the 1991 balance-of-pay crisis and no external sector crisis, and two, the Reserve Bank of India (RBI). ) Created adequate cautionary forex reserves to withstand any pressure on the rupee. Finally, the RBI could sell only $ 18.4 billion in April 2013, or 6.3% of the total reserves ($ 294 billion), insufficient to stop the sharp devaluation of the rupee between May and August of that year. It was realized, quite early on, that foreign exchange reserves built on capital account surpluses did not reflect actual external strength, the value of the rupee was significantly exorbitant, and a correction was overdue.

On May 4 this year, when RBI Governor Shaktikant Das rushed to announce a mid-cycle policy rate hike, the market was buzzing with speculation as to what triggered the panic. Is the RBI trying to follow the obvious flaws in its inflation forecast, or is it protecting the rupee ahead of the US Federal Reserve’s monetary action that evening? While most post-policy analyzes focus on the significant reversal of the RBI’s April inflation forecast (inflation 7.8% in April 2022), some pointed to the tendency for a steady decline in foreign exchange reserves. So far, the RBI has sold about $ 42.6 billion, that is, 6.7% of the স্ট 640 billion reserve stock by the end of October 2021, and it would seem increasingly incapable of further depleting these in an attempt to protect the rupee.

This could be both, since a weaker rupee means a higher passthrough during the rise in international commodity prices, which disrupts the outcome of inflation. But, from the point of view of policy analysis, it is important to know which of the two is the main concern. If the RBI responds to internal inflation, the increase in data dependence will probably provide some space for strategy. But, if it tries to protect the currency, it risks being tied to the Federal Reserve’s rate cycle.

Central banks never disclose their exchange rate strategies, and the RBI’s stated position is that it only intervenes to smooth out volatility. To keep this in mind, it’s important to revisit the 2013 Taper Tantrum episode and the lessons learned from it. First, there was an unspoken hesitation in imposing restrictions on gold imports that was at the root of the growing current account deficit long before the trivial turmoil. Second, the RBI was reluctant to use the forex reserve to curb the devaluation of the rupee and thus released the corporate balance sheets with hedgeless forex exposure. And third, there have been significant delays in raising interest rates and meeting foreign exchange reserves. It is noteworthy that the report of the Urjit Patel Committee in January 2014 (para V.24) clearly stated that the interest rate response was found to be most effective in the 2013 period and will be the first round of capital outflow response in the future.

It is also worth recalling the current account deficit estimates in 2018 due to the shock caused by rising oil prices, lagging exports and continued outflows of portfolio capital. The reserve peaked-to-trough decline (21 21 billion from mid-April to July 20, 2018) or 5.8% of March-end stock of 42 424.5 billion matched that of April-August 2013, when the rupee was three times higher (15%). Although forecasts to issue $ 20-22 billion NRI deposits have begun to appear. Things were no different despite a larger stock of reserves! The game is the amount of reserves spent to support the currency and time to keep the weakness indicators stable (as a ratio of stocks to stocks, it gets worse with the decline of the previous one!), Maintaining market confidence and not distracting emotions.

In 2013, anger was limited to the Federal Reserve chairman’s intention to start reversing his bond purchases. However, the works were not implemented in the end and the dust settled in a quarter. In contrast, in 2022, the central banks, especially the world’s reserve issuers or the US Fed, have abandoned all guidelines – the only clear fact is that monetary measures, delayed and too short, have only just begun. There is much more to come, with exceptional uncertainty in the truly troubling geopolitical and economic context. Compared to the short-lived taper tentram, the 2022 situation demands real action, which could be long-lasting with real economic repercussions. If it was 2013, would it all be over by June? But everyone knows that inflation is not temporary but real, spreading to all corners. No one knows the direction of the US Federal Reserve or its economy, China’s growth prospects, and the effectiveness of inflation targets over the past three decades.

Reflecting its 2013 lessons, the RBI began intervening long ago in anticipation of changes in US monetary policy, increased instability from the Russia-Ukraine war, and anticipation of its impact on prices and supplies. It was calm, provided confidence that inflation was manageable, and did not accelerate fiscal measures in advance. However, as in 2013, the central bank delayed raising interest rates to the point that the exchange rate came into focus. This, in addition to the post-April 8 internal inflation assessment, has probably forced an out-of-cycle increase. Both the interest rate and the exchange rate are combined, and a correction may be forced otherwise.

What should be expected up front? One, the situation has become fragile as reserves have shrunk at a significant rate. The RBI has spent too quickly; It has probably been left in little control, and firepower needs to be saved for the long haul of normalcy towards moderating the rupee balance. Two, interest rate measures to control inflation have just begun and there is a long way to go.