The impact of the US Federal Reserve’s announcement in November last year to scale back its asset purchases has been “moderate” on Indian financial markets, largely due to the country’s strong external position in 2021, according to an article.

The article published in the July Monthly Bulletin of the Reserve Bank of India (RBI) compared the impact of the two cuts announcements (22 May 2013 and 3 November 2021) by the US Federal Reserve (Fed) on Indian financial markets .

The article – Fed Taper and Indian Financial Markets: This Time is Different – ​​is prepared by Vidya Kamate and Saurabh Ghosh of the Strategic Research Unit, Department of Economic and Policy Research, RBI.

The central bank said the views expressed in the article are those of the authors and do not necessarily represent the views of the RBI.

The authors said that in terms of changes in government bond yields, the yield curve and the exchange rate, the impact of the Taper 2 announcement (November 3, 2021) turned out to be rather moderate. .

Compared to the announcement of Taper 1 (May 22, 2013), movements in the volatility of Indian stock, bond and money markets were also observed to be rather subdued during the announcement period of Taper 2.

“India’s subdued financial market response to the Taper 2 announcement may be related to the strong position of the country’s external sector during the Taper 2 announcement period,” the article said.

In response to the global financial crisis, the Fed’s large-scale asset acquisition program was launched in November 2008.

On May 22, 2013, Fed Chairman Ben Bernanke first hinted that the Fed might reduce quantitative easing (QE), also known as Taper 1, causing the market to collapse bond which increased the 10-year yield by nearly one percentage point.

In the wake of dysfunctional Treasury and mortgage-backed securities (MBS) markets after the outbreak of COVID-19, the Fed announced on March 15, 2020 that it would purchase at least USD 500 billion of Treasury securities and 200 billion USD in MBS.

On November 3, 2021, the Fed announced a reduction in asset purchases of $10 billion in Treasuries and $5 billion in MBS per month (Taper 2).

In December 2021, the Fed announced a doubling of its rate of cuts and said asset purchases would end in March 2022.

Explaining the differential response of financial markets during the two reduction announcements, the authors said that the announcement of Taper 1 surprised financial markets around the world and, as a result, caused a significant adverse reaction.

The announcement of the Taper 2, on the other hand, was somewhat anticipated by financial markets given past experience with the Taper 1 and the communication from the Fed subtly hinting at the odds of typing in the lead up to the announcement. of the Taper 2, they said.

Another potential explanation for the resilience of Indian markets after the Taper 2 could be support from stronger economic fundamentals in India as opposed to the period before the Taper 1 announcement, according to the article.

“A lower current account deficit as a percentage of GDP, larger foreign exchange reserves and stronger economic growth in Taper 2 compared to Taper 1 imply that the Indian economy is in much better shape to withstand Fed tightening and manage any associated changes in financial market volatility,” he said.

The article states that inflation dynamics in India were also quite different in the announcement period of Taper 1 compared to Taper 2.

Unlike the multiple indicator approach in 2013, monetary policy in India currently operates under an inflation targeting regime with a well-defined inflation target that anchors inflation expectations, it said. -he declares.

Meanwhile, another article – Electrification of Forex Markets in India published in the newsletter stated that the electronicization of global foreign exchange (FX) trading with the emergence of multi-banking platforms has transformed the trade execution and price discovery.

Some of these changes can be seen even in the onshore Indian Rupee market, albeit in a limited way.

The article is prepared by Abhishek Kumar and Nitin Daukia of the Financial Markets Regulation Department (FMRD), RBI. The central bank has stated that the opinions expressed in this article are those of the authors and do not necessarily represent the views of the RBI.

The electronicization of global currency trading, in recent times, has been characterized by the emergence of new forms of trading platforms, such as Single Banking Platforms (SBPs) and Market Makers, including leading trading firms (PTFs), he said.

These developments have altered the structure of the market with increasing market fragmentation, such as the dispersion of foreign exchange trading across a wide range of trading venues, and internalization, such as dealers, increasingly clearing trades. between customers instead of hedging the risk in the inter-dealer market.

In recent years, SBPs have also become increasingly visible in the Indian forex market, with trading volumes increasing on these platforms, he said.

They said structural changes in foreign exchange markets had implications both for policy-making, particularly regarding transparency and pricing for customers, as well as central bank oversight over the foreign exchange markets.

The article further states that electronization has fundamentally changed the way prices are discovered and liquidity is provided to users in financial markets.

“Market surveillance needs to evolve proportionally and continuously to effectively track structural changes due to these trends,” he said.

At the same time, opportunities emerging from electronization should be exploited to increase market transparency, reduce information asymmetry and improve pricing for users, according to the article.

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