Prepare for rate hike by US, Lagarde tells India

International Monetary Fund managing director Christine Lagarde has indicated that emerging markets should be prepared for a rate hike in the United States sooner or later.

“The danger is that vulnerabilities that build up during a period of very accommodative monetary policy can unwind suddenly when such policy is reversed, creating substantial market volatility. We already got a taste of it during the ‘taper tantrum’ episode in May and June of 2013, when most emerging market economies suffered indiscriminate capital outflows. India was also affected,” Lagarde said at an event in Mumbai.

I am afraid this may not be a one-off episode. This is so, because the timing of interest rate lift-off and the pace of subsequent rate increases can still surprise markets, Lagarde added. According to her, advanced economies can certainly help in minimising negative spillovers of the taper tantrum and emerging markets should prepare in advance for such an event.

Taper tantrum lessons“There are many important lessons we have already learnt from the taper tantrum episode that I would like to share with you. First and foremost, advanced economies can help. Clear and effective communication of policy intentions can reduce the risk of creating very large market volatility.While admittedly it is a difficult task, I would also agree that there is scope for greater international policy cooperation to minimise the negative spillovers,” Lagarde said.

Emerging markets need to prepare well in advance. Evidence from our research suggests that emerging markets that had already addressed their economic vulnerabilities before the taper tantrum fared better during episodes of market volatility, Lagarde added.Lagarde also lauded the ‘decisive actions’ taken by the Indian central bank to contain vulnerabilities. 

“The Reserve Bank of India (RBI) took decisive action during and after the taper tantrum episode. It provided foreign currency liquidity support to key sectors, allowed the rupee to depreciate, and provided judicious foreign exchange interventions to minimise disruptive movements in the rupee,” she said. 

“The RBI also arrested the surge in gold imports, narrowed its current account deficits sharply, and started to rebuild foreign exchange reserves,” Lagarde said.DH News Service