How the US Fed tapering bond purchases will impact India

What was the outcome of the FOMC meet?

Federal Reserve chair Jerome Powell said if the US economy continues to strengthen, the central bank would soon dial down its monthly asset purchases of $120 billion and conclude the tapering process by mid-2022. Although the Fed did not set a date to start the tapering process, it has indicated that it could be as early as its next scheduled monetary policy meeting in November. The policy rates have remained unchanged since mid-March 2020, when it was reduced by 100 basis points (bps) in an emergency move in the wake of the coronavirus outbreak,

What were the key policy statements?

The Fed held its current target interest rate steady in a range of 0% to 0.25%, and said its accommodative policy will be maintained until the US economy achieves maximum employment and inflation is at the 2% target. The Fed will purchase $80 billion of treasury securities and $40 billion of mortgage-backed securities per month. Powell also said the debt problems of property developer Evergrande seem specific to China, and there is no parallel with the US corporate sector. “China has very high debt for an emerging market economy," the Federal Reserve chairman said.

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How does the FOMC meet outcome impact India?

Ultra-loose monetary policies by global central banks attracted massive funds into emerging markets. Foreign institutional investors (FIIs) have pumped $7.94 billion into Indian equities so far this year. The Sensex and the Nifty have gained 23-25% in 2021. But higher interest rates will tempt large foreign funds to shift their money back to the US, which will affect local markets.

Why are monetary policies divergent?

So far in 2021, 12 major emerging market central banks have started rate hike cycles, of which 10 are outside of Asia. Central banks will find it challenging to exit their ultra-accommodative policies, analysts say. The Bank of Korea was the first out of the ranks, but it is not clear whether it is the right policy. If Asian central banks remain accommodative for far too long, this could result in two medium-term risks: inflation in emerging markets in Asia, and a debt build-up in developed markets in Asia, said Nomura.

Will RBI normalize policy rates now?

While the tapering of US asset purchases will have implications on the flow of funds into India, it is unlikely to be immediate. The monetary policy of Reserve Bank of India RBI would continue to be driven by domestic considera-tions of economic growth, but towards this end, it would continue to maintain its accommodative monetary policy, said Care Ratings. India has the highest inflation rate in the region, but RBI is tolerant. Nomura sees policy normalization starting with a calibrated normalization of liquidity in Q4.