We talked to leading economists and fund managers to help you make sense of what is happening in the US and how it could impact emerging economies like India. This is what Abheek Barua, Chief Economist- HDFC Bank, had to say:
How will tapering affect emerging economies like India?
We have been dependent on capital flows that have been on the back of high liquidity to a large degree created by the Fed's QE program. Any reduction of that liquidity could actually affect flows coming into emerging markets, including India.
It can also affect the sentiments because investors in Indian stocks are aware of the fact that there has been a current account gap, which was being funded through capital flows, which in turn was linked to the liquidity infusion program. So that could set off a vicious cycle where people start shorting the currency and pull out of assets like equities.
From India's perspective, the current account deficit has come down so the impact of the taper would also be far more limited because we do not need the kind of flows that we needed last year to fund the current account deficit.
How do you see the tapering progressing?
What happened as a result of the initial indication of taper was that interest rates in the US started moving up very sharply, and clearly the US cannot afford that at this stage. So I think the taper, if at all, will be very gradual and would be closer to a number of a 10 billion dollar taper from the $85 billion that they are infusing now.
When do you think the Fed would actually get started with the tapering programme?
We really don't know. The markets have tentatively put a time of December (2013) to it. The new Fed chairman (nominee) Janet Yellen has been known to be very dovish. But given the fiscal challenges that they face especially in terms of the debt ceiling and so on and the fact that there will not be a conclusive resolution to it right away, it is possible that the taper could get pushed back even further.
How serious is the US debt default scenario and how do you see it playing out?
It is serious, but they will find a short-term solution around this. But it will only be a short-term solution, not a permanent one, which means that this problem will crop up again in the next few months and hang over the US economy and markets for a while. I think US debt defaulting is something that lawmakers will not allow. So let's just hope for the best.
But if they raise the debt ceiling, they would get over the problem?
Yes, but that's really it. The cycle will become more and more vicious.
How long can they keep doing that?
They can do it indefinitely, but it depends. They still need to do it for a little more time.