Tapering can be described as a plan to ‘wind down’ or ‘taper’ the Quantitative Easing (QE) or to gradually stop investing money into the economy and the banks. The central banking system does so by reducing bond purchases over an extended period to wean the economy slowly off the extra stimulus the purchases provide to avoid a nosediving.
What is Taper Tantrum?
In 2013, the US Federal Reserve decided to reduce its quantum of a bond-buying programme (known as quantitative easing) it began in response to the 2007-2009 global financial crisis and recession that led to a sudden sell-off in global bonds and stocks.
As a result, many emerging market economies, that received large capital inflows, suffered currency depreciation and outflows of capital. Eventually, that phase came to be known as a 'taper tantrum'.
Global markets took fright at the Fed's first hint that it might unwind its monetary stimulus in what became known as the taper tantrum.
US Fed's tightening of asset purchasing power triggered US Treasury yields to race higher back in 2013, an episode in financial markets referred to as a 'taper tantrum'. The Fed was only able to start shrinking its balance sheet in 2017, nine years after it began expanding it during the global financial crisis.
In India, foreign institutional investors (FIIs) withdrew money from both bonds and equities, and the value of the rupee dipped over 15 per cent between May 22 and August 30, 2013. Consequently, the Reserve Bank of India (RBI) had to raise interest rates to control the outflows.
Emerging markets including India are vulnerable to getting impacted on account of the United States Federal Reserve’s decision to scale back its quantitative easing program. Reduction in US Fed's monthly liquidity injections into the economy affects inflation in these emerging countries despite the positive impact that currency depreciation has on their external imbalances.
What happened in 2021?
Global financial markets in August 2021, were rattled on the back of minutes of the Federal Open Market Committee (FOMC) meeting that indicated an earlier-than-expected tapering of its $120 billion a month bond-buying program.
From a market standpoint, a sooner-than-expected taper could cause some jitters in the risk-on trade in equities, and can trigger US Treasury bond yields to surge higher, according to Christopher Wood, global head of equity strategy at Jefferies.
Rupee loses 10% vs USD over a year, FX reserves fall to near 2-yr low
India spending forex reserves at quicker pace than during taper tantrum
