What is a black swan event?

In the Reserve Bank of India’s latest bulletin, an article titled ‘Capital Flows at Risk: India’s Experience’ cautioned about an event -- comprising a combination of shocks -- which might lead to portfolio outflows of about $100 billion or Rs 7,80,000 crore. Authored by RBI Deputy Governor Michael Debabrata Patra, along with Harendra Behera and Silu Muduli, the report called for maintaining liquid reserves to deal with the event which is known as black swan.

The theory of black swan was first floated by finance professor and former Wall Street trader Nassim Nicholas Taleb in 2001. Taleb went on to write a book on it titled, 'The Black Swan: The Impact of the Highly Improbable'.

So what exactly is black swan event? It is a rare and unpredictable event with potentially has severe consequences.

In his book, Taleb says that there are three attributes of the event. The first is that it is an outlier and cannot be predicted. The second is that it has an extreme impact and the third is the human nature to try to concoct explanations once it has happened.

It can be characterised by a combination of all adverse shocks experienced in the history coming together, leading to a perfect storm.

What are some of the recent examples of black swan events? In hindsight, the global financial crisis could be termed as a black swan event as the sudden collapse of the US housing market led to a severe global economic crisis. The 26/11 terrorist attacks, the burst of dot.com bubble in 1990s are the some other examples of black swan events.

In the context of capital flows, the RBI report says that capital outflows, particularly, portfolio flows are driven by global risk aversion and they are sensitive to shifts in risk sentiment globally. So, if there is an adverse event like “Covid-type contraction in real GDP growth” or “global financial crisis type decline in interest rate differentials”, India could see capital outflows to the tune of 3.2% of GDP or approximately $100 billion.