5 Trillion Economy

forecasting inflation to be this high last year. Purely looking at their numbers you'd think that they're underestimating inflation. For example, if you ask whoever cooks at your home, they'll tell you cooking oil prices have gone up a lot. But that is a function of our imported commodities. Like palm oil has become expensive, and partly that is because there are not enough people in Malaysia to harness it, so labour costs have gone up. The moment the borders open, they'll be able to import more labour, and the cost arithmetic of palm oil will go down, and you will see prices correcting down. So, you do have mean reversion in inflation so I won’t necessarily say that this inflationary trend will be there with us for the next two years. Nothing like that. But there was a clear underappreciation of the bottlenecks that we have. And on the demand side, the labour markets have tightened, wage growth is picking up in certain places. But a real demand led inflation bout is something we haven't seen in a long time. If that comes, the challenges of monetary policy will compound. But at the moment it seems very supply centric.

Question: Do you foresee a Taper Tantrum 2.0?

Taper Tantrum is the name given to the episode back in 2013, when the FED suddenly announced that they will be tapering their purchases of government securities. As part of the stimulus program in 2008 the US Federal reserve had announced that they will be doing quantitative easing, which in modern day parlance is the Central Bank keeping rates at record lows and once you've run out of rates to cut, you start buying assets to make sure the long end yields come down as well. So they did QE 1, 2 and 3 over five years between 2008 to 2013, and in May 2013 the FED announced that they'd be tapering, which was implicitly a signal to the markets that they are now fine with long end yields increasing. This was a period when countries like India, Mexico, Turkey, Brazil, Indonesia were part of the fragile pipeline and they had very high Current Account Deficits to finance. They were consuming and investing too much compared to their total savings, so they were borrowing quite a bit from the world to finance their consumption and investment. So Current Accounts tend to be very sticky. So at that time when tapering happened, the uncovered interest parity meant that the US Dollar started to appreciate because the interest rates were rising in the US relative to other emerging markets. And as a result of that, money started flowing out of bond and equity markets from these countries, with the expectation that rates in US are going higher, it's more profitable to be investing in US markets. As a result of that, we had very large-scale value loss both in terms of currency and fixed income space for these countries. That was the Taper Tantrum and that was the period when India saw the rupee going from around 54 to 68 and it appreciated back to 62 in a very short span. Is there a possibility of a Taper Tantrum 2? Well, even if there is, the Central Banks are better prepared because they have larger foreign reserves, and they are a lot more aware of not making the same mistakes. The good thing from an Indian perspective is that our Current Account financing requirements are very low at the moment. So, while our trade deficit is widening, we are also getting a lot of inflows. There's a lot of capital inflow coming in, companies are raising funds and that makes the supply of dollars in the system quite high. So the probability of the rupee having a similar, say 10%-20% depreciation in a short period of time is miniscule. That should prevent India from getting materially impacted in a Taper like scenario, but yes, you can never completely rule it out.