TAPERING: False Alarms

It has become a pattern of sorts in recent times for the global markets to shudder at the thought of the commencement of tapering each time the US announces a strong set of economic data points. That word - ‘tapering’ - has come to acquire such an ominous connotation that the even slightest mention in the corridors of the Federal Reserve sends investors all over the world into a tizzy.

The Back Story 

To put things in perspective, ‘tapering’ refers to the scaling down of the bond buying exercise which had been initiated by the Fed in order to help the US economy tide over recessionary pressures. After the first two quantitative easing programmes (which failed to boost the economy as required), the US government had undertaken this third one, through which it is buying bonds and securities worth USD 85 billion every month to help the economy get back to growth. 

Simply put, the US central banker is currently printing currency worth USD 85 billion a month and pumping it into the system by buying securities of an equivalent amount to keep the long-term interest rates at a lower level. The supply of money is hiked artificially, which finds its way into the financial markets. That higher money supply is, in turn, expected to go into asset building and creation of enough growth opportunities for the economy.

However, the problem with the third round of monetary easing in the US (and in fact all of those that have happened so far) is that the money supply that was created has found its way into foreign financial assets through banks and institutions. A bulk of this artificially generated liquidity has found its way to emerging markets, particularly to countries like India, Indonesia, Hong Kong and other South East Asian economies.

This becomes clear from the trend of investments by FIIs in the Indian context. After putting in a humongous Rs 128360 crore last year, they have poured in a net Rs 96477 crore in the Indian markets so far in this calendar year. That should give you an idea of the kind of money that flows into international monetary assets from the US.

More Than Meets 

The Eye While the outflow of funds sometimes augurs well for the US financial sector, it certainly hurts on two counts. One, there is no physical creation of assets that can boost growth. Two, the dollar weakens vis-à-vis other currencies as the supply is anyway in plenty. This is why you hear about how asset rallies today have more to do with the flood of liquidity than a play of fundamentals.

To assume that policymakers and regulators in the US aren’t aware of this situation will be completely naïve. Bearing full knowledge of it, they have devised their own way of handling the situation. Now, every noise, big or small, which hints even remotely at the strengthening of the US economy, leads to talks of tapering. The moment this happens, financial markets all over the world go into a frenzy worrying about the dollar outflows that could happen if the taper begins. 

The fact is, there is no way the US can afford to begin tapering the stimulus programme any soon. In fact, the basic premise of growth in the US economy picking up and hence warranting the beginning of the tapering sounds sheerly impractical. The basis on which the growth up-tick is being measured is even more ludicrous. Job creation data is being looked upon as a sacrosanct measure of how good the economic turnaround is looking. The moment there is the slightest improvement in the job creation data or even a fall in jobless claims for that matter, the clamour around tapering gets louder.
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The US has a total population of 31.71 crore. Of these, civilian labour accounts for approximately 49 per cent and non-farm payrolls are around 43 per cent. The country, as a whole, has been adding around two lakh jobs over the past six months, which averages out to a miniscule 0.15 per cent of the total non-farm payrolls. The numbers speak for themselves. There is no way that such a small percentage of or even these absolute numbers can become the cause for the taper of a support mechanism that has kept the economic engine running.

The Ground Reality 

As a matter of fact, there is a definite set of parameters which will determine when the taper will begin. The government needs to bring down the unemployment rate to below 7.2 per cent and the employment up by about 22 lakh in the month of November before it can begin with the taper. In addition to this inflation needs to rise to around two per cent, and not to forget the fiscal agreements that are to be reached by the end of December this year on certain vital matters.

With so much yet to happen, there is no reason why US policymakers should be even hinting at the so-called tapering of the stimulus programme. Yet they do, and we continue to react in a frenzied fashion.

The only thing that the US is achieving by making this noise about the taper is to scare dollars away from economies like India and back into the US. This surely helps in stabilising its currency to some extent. But the impact that has been seen on the markets here is incredible. The moment they look to be north-bound based on supportive factors on the domestic front, the US fuels speculation about the taper and pulls them down. 

The markets being driven primarily by FII inflows is far from being a new phenomenon. Cracking the ‘taper’ whip to bring back the dollars has become a sort of a rhetoric or statement on the part of the US administration, but there is no reason why this should create a panic situation in the Indian context. The RBI governor has gone all out to express the readiness of the Indian economy in handling the taper situation as and when it begins. In one of his recent statements he said that what is left is more patient money, but given its diminished size, its possible exit does not look like a huge risk.

Dr Rajan certainly seems to have a unique knack of reading global geopolitics and taking a stance on the country’s monetary policy accordingly. His leanings in this direction became clear when he first postponed the monetary policy review ahead of the Fed meeting, and later used it to his advantage to hike the interest rates. More recently, in the second such instance, he broke tradition by coming out into the open to addressing fears on a rising rupee and assuring that the CAD was likely to come in much below the Finance Ministry’s latest estimates.

Smart judgement or information possession, either way, is certainly helping the cause of the Indian markets for now. Having said that, investors would do well to maintain caution, as a fundamental shift in the fortunes of the economy is still some time away. Unless the situation on the ground makes it obvious that an improvement is indeed happening, take every euphoric rise with a generous pinch of salt. So, if you are in the market and get the next hint of ‘tapering’, don’t let your heart skip a beat. There is no way that the US can afford to begin it any sooner, and even if it does, believe our policymakers when they say that India is prepared!