India stronger now, Fed taper has had a moderate impact: RBI paper

Vidya Kamate and Saurabh Ghosh from the RBI’s strategic research unit analysed India’s benchmark bond’s movement after the two taper announcements by the Fed in May 2013 and November 2021 and found that the impact on the 10-year government bond yields was moderate (5.46 basis points) in the latest event as compared to May 2013 (11.32 basis points).

“The slope of the yield curve remained unchanged during Taper 2. The increase in 10-year yields was on the expected lines given that the taper announcement served as a signal for a reduction. One potential explanation could be that the Taper 1 announcement caught the financial markets across the world by surprise, and hence, led to a significant adverse reaction. Taper 2 announcement, on the other hand, was somewhat anticipated by the financial markets given the past experience with Taper 1 and Fed communication subtly hinting at chances of taper in the periods leading up to Taper 2 announcement,” Kamate and Ghosh said.

Stronger Indian economic fundamentals currently could also be another potential explanation for the resilience in the Indian markets post Taper 2, the researchers said.

“A lower current account deficit as a percentage of GDP, larger foreign exchange reserves and stronger economic growth in Taper 2 vis-à-vis Taper 1 period imply that the Indian economy is in a much better shape to withstand Fed tightening and manage any associated change in volatility in financial markets,” the paper said.

The Indian bond market reacted strongly to the Taper 1 announcement with the yield curve (10-year minus 2-year) inverting in the months following the May 2013 announcement with 10-year yield falling by 19 basis points and the spread by 21 basis points. A yield curve inversion is usually treated as a precursor to recession. In comparison, Taper 2 announcement has had an insignificant impact on Indian bond yields.

There was significant exodus of foreign portfolio investment (FPI) flows from India and a steep depreciation of the rupee following the Taper 1 announcement. The FPI outflow in the June to August 2013 was approximately 78,000 crore, most of it from the debt market.

In contrast, the rupee experienced a mild depreciation following Taper 2 that was quickly corrected in the following weeks. FPI outflows have been moderate and mostly in the form of equity in the immediate aftermath of Taper 2.

Though the Indian financial markets have been only mildly impacted by Taper 2, there are evidences of large volatility spill-overs from the US to Indian equity and bond markets. “This emphasises the need for readiness among EMEs in terms of adequate buffers, pre-emptive and calibrated state contingent and data-dependent policy responses to withstand future volatility spill-overs,” the paper said.