The US Fed decided on a $10 billion taper today. From buying $85 billion worth securities per month, they will buy only $75 billion worth, including $35 billion of Mortgage Based Securities (MBS) and $40 billion of government bonds. (The deal is to take off $5 bn from each, from January)
This is accompanied with a strong statement that interest rates will remain at zero until inflation crosses 2%. The unemployment target is 6.5% or lesser, but rates could stay low even if that is achieved if inflation targets are not reached. The visibility into this says: not till 2016 will we raise rates.
They also said they’ll continue to pay interest on reserves. So financial institutions can continue to borrow at near-zero, and put it back into the Fed at 0.25%; the free money game is still on.
But the Markets Went UP on the Taper!
The US markets went up 2%. No one knows why. It’s probably that someone said goodbye to the taper and this happened:
I thought in the morning that Indian markets would go up. They didn’t. They are down 1% or so today. Banks were down 2%, while IT was up 2%.
The rupee is at Rs. 62.3 to the dollar. This is a near term high for the USDINR.
The US Bond yield was down - when a taper should have made it go up. It ended at 2.88%.
Gold has fallen 2.5% in US dollar terms, but not so much in rupee terms.
How does the US Taper Impact India?
There’s much more in Capital Mind Premium’s letter today, but here’s the gist. A US taper reduces the amount of money foreigners will invest in India. We know that our current account deficit is large and is bridged by financing, through:
- rupee depreciation (undesirable)
- foreign debt or equity inflows (desirable)
- NRI deposits (desirable)
The desirable options depend largely on how much India remains attractive, Without them we end up with rupee depreciation.
We’ve done the do on NRI deposits and it may not be great to do it any further. For Foreign inflows, we’ve done well in the last month or so. Yet, the taper may change that. In that it may increase market yields of bonds in the US, so our “spread” comes down, and therefore people can get dollar denominated assets at a higher yield, which they may choose to invest.
Second, consider $10 billion a month now is $120 billion a year, and perhaps even more because the US is going to reduce this buying. We have seen only $10 billion come to India as portfolio flows in 2013. What if that goes away because the US isn’t really flooding the market with money anymore?
Markets in India aren’t rejoicing yet. Let’s see how it all pans out, while Europe sings and dances.