Taper Tantrum

Many of us have heard this news coming from various experts, analysts and news channels in the last 2-3 months. What exactly is taper tantrum? Let’s deep dive into this Jargon which many of us are unable to understand at the first go.

In 2013, Federal Reserve (US central bank) chairman Ben Bernanke announced the future tapering of the policy called quantitative easing by which it will reduce the speed of the purchase of treasury bonds and eventually reducing the speed of money that was fed into the economy.

Quantitative easing:

When central banks around the world try to push liquidity into the system by purchasing securities.

Since the 2008 financial crisis, the fed has been doing Quantitative easing program and its balance sheet got expanded from ~ $1 trillion to ~$3 trillion by purchasing the securities. Given that the fed is not going to purchase bonds or the speed will reduce, the prices of these securities started to fall and correspondingly, yield started to rise, similarly increasing the cost of borrowing. By all this and chasing higher yields affected money going out of the markets around the world, and indices fell down.

(Bond prices are inversely proportional to the yields)

Whenever there is a crisis situation, central banks try to push liquidity into the system by purchasing securities. (Open market operation or Quantitative easing)

Since the start of the Covid pandemic, the fed has been expanding balance sheet and pushing liquidity into the system through various measures. If it is announced that the fed will taper the bond purchase, it will give rise to higher yields, easy availability of low-cost funds may go down and chances of money flowing out of emerging markets such as India.

Currently, India holds ~$640 billion foreign exchange reserves, and the FDI is increasing day by day. This taper may change all the numbers and it might negatively impact India.