Forex party is ending: ON US Fed Balance Sheet Tapering

News: US Federal Reserve (Fed) is increasing the speed of balance sheet tapering.  

As mentioned in the news, US Federal Reserve (Fed) will double the pace of its balance sheet tapering and end its net asset purchases by mid-March 2022.  

Balance sheet tapering means gradual slowing of the pace of the Fed’s large scale asset purchases, which was aimed at providing monetary stimulus to the economy. It may also lead to increase in interest rates.  

US balance sheet policies always have a major effect on the economies of emerging countries. When US cuts interest rates and expands balance sheet, it triggers capital inflows, local currency appreciation and higher asset prices in emerging markets. 

Why India is better prepared against any ill-effect of US balance sheet taper? 

Unlike 2013 taper, this time the affect will not be substantive in India, due to the following reasons:  

First, federal reserve has communicated its intentions a bit early this time. It has provided some time to the economies, to be prepared. 

Second, India is less vulnerable to external vulnerabilities now. It is because Rupee is not overvalued, as was the case in 2013. Also, India’s current account is in surplus and Foreign Currency reserve currently cover nearly 12 months of imports. 

Third, basic balance of payments (BBOP) is in surplus (BBOP is the sum of current account and net FDI inflows).  

What are the causes of concern? 

However, there are also, reasons of concern:  

–The Current Account trend is changing. Merchandise trade deficit is widening.  

–Higher commodity prices such as crude oil, metals, etc., and improvement in domestic demand is increasing India’s import bill. 

–Gold imports have surged over the last year, rising to $55 billion in the 12 highest since 2013.  

–India’s BBOP is going into deficit from surplus.  

–High relative inflation, compared to competitor Asian countries can erode it’s export competitiveness. 

Source: This article developed based on the article “Forex party is ending: ON US Fed Balance Sheet Tapering” in Times of India on 4th January 2022.