Today's Editorial

Today's Editorial - 10 November 2023

Emerging resilience

News Excerpt:

The US Federal Reserve's (US-Fed) withdrawal of pandemic-era policy accommodation and a significant increase in policy rates since March 2022 have heightened fears of a "taper tantrum 2.0" among emerging-market economies (EMEs).

Key Points:

  • A recent analytical article by economists at the Federal Reserve Bank of San Francisco strengthened this argument that-
    • Despite these concerns, emerging markets, particularly India, have demonstrated extraordinary resilience. 
    • This demonstrates that, while policy tightening in the United States and other developed countries can disrupt financial markets and tighten financial conditions in emerging markets, strong domestic fundamentals can help protect the economy from adverse economic shocks.
  • The article looked at the changes in 10-year government bond yields for 16 EMEs to evaluate the global market response to the onset of policy tightening by the Fed. 
  • The findings revealed that a one standard deviation increase in the Current Account Deficit (CAD) in EMEs resulted in a 40-basis-point increase in the 10-year government bond yield spread over the first half year after policy tightening began. 
  • This statistically significant relationship showed that countries with current account surpluses exhibited lower changes in spreads and were better positioned to absorb the policy tightening than countries with CAD. 
  • Further, pandemic-related fiscal spending on health and social welfare was found to have a negligible impact on changes in 10-year bond yield spreads. 
    • This may perhaps also be because countries spent less due to existing fiscal constraints. 
  • Thus, a large CAD in EMEs can be regarded as a bigger macroeconomic flaw going into episodes of sudden tightening of global financial conditions.

About taper tantrum:

  • In technical terms, A taper tantrum occurs when a central bank, such as the United States Federal Reserve, indicates or declares that it may reduce (or "taper") its asset-buying program. 
  • The “taper tantrum” occurred in 2013 when the US Fed announced its plans to taper the quantitative easing programme started after the financial crisis of 2008.
  • The announcement led to a “sudden stop” of capital flows into EMEs like India. During the Taper Tantrum of 2013, India's macro stability came under significant pressure.
  • This not only led to capital outflows, but India was also running a large CAD, which needed to be financed. 
  • The incident ultimately resulted in a substantial drop in the rupee's external value. Notably, India was not the only country facing this crisis. 
    • Several EMEs faced similar conditions and India was made part of the “fragile five”. 

India’s performance at that time:

  • However, things have been very different that time. India has managed the situation particularly well, which has led to reasonable stability in the currency market. 
  • The Reserve Bank of India (RBI) used every opportunity to accumulate foreign exchange reserves. 
    • It was helped by the sharp increase in capital flows in 2020 after large central banks, particularly the Fed, flooded the system with liquidity.
  • India’s foreign exchange reserves swelled to over $640 billion in 2022.  
    • While the sudden increase in global interest rates and a sharp move in commodity prices owing to the Ukraine war led to outflows in 2022, the situation was managed well by the RBI.
  • The adoption of inflation targeting in India and other EMEs also helped.
  • India and other EMEs could move more freely in terms of monetary policy action, which helped improve confidence in financial markets.


While the RBI has done well thus far, and the moderation in the CAD has helped, risks to macro stability remain. Low risk appetite among global investors, worsening geopolitical conditions, and persistently high fiscal deficit can increase challenges. Hence the Indian government and RBI should focus on a futuristic approach to the Indian economy so that such incidents cannot affect our market and economy.

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