Quantitative Easing by the US Federal Reserve: Its effect on India
What is Quantitative Easing?
QE or Quantitative easing was a unconventional policy introduced by the US Federal Reserve (Simply called Fed) which is the Central Bank of USA, like RBI is for India.
Essentially QE implies the policy of the Fed to buy bonds in the open market to essentially ease out liquidity that is to push more money into the market and system. At its latest version i.e. QE3 the Fed was pushing nearly $85 Billion into the market every month through these purchases.
How does QE help? Or what is its main purpose?
QE was a result of the great depression of 2008, by which investor sentiment was much muted globally and especially in the US. Due to the bust (depression) investor sentiment was very low as well as people were not investing in markets, nor taking loans for housing, as well as unemployment was spreading.
To counter this initially the Fed lowered all sorts of rates to bring interest rates down (similar to RBI reducing CRR, SLR, Repo rate etc to reduce interest rate of loans in India). However even after reducing these to the minimum the Fed felt that the investor sentiment was not pushing up and loans were still expensive. So it decided to push money into the hands of the market for use. So basically the Fed hoped to drive up the supply of money available for loans, driving down long-term interest rates so more people would buy and build homes and invest in businesses.
Wouldn’t that extra money result in Inflation?
Technically yes. But practically no. It is true that now there is way more money in the system chasing the same products and so would technically lead to inflation. But we also have to consider the fact that the USD (US Dollar) is a hard currency and freely convertible around the world, and in much demand as it is considered as a stable investment (US is the world’s biggest economy after all). But, instead of all the money staying in the US and in the US market, most of it made its way around the globe to the other economies and countries, one of which was also India.
The people with all the money in US realised that they could not earn much by keeping their money in US Banks or stock market since returns are very low, so why not invest this around the globe in different emerging market stock markets to earn better returns. This resulted in free flow of all the extra money to global markets one of which was India. India’s Sensex and Nifty had been giving very good returns for quite some time and so we saw an influx of FII investment. This helped us not only sustain a larger Current Account Deficit but also made the INR (Indian Rupee) appreciate w.r.t . the USD. A similar event was occurring in nearly all emerging economies around the globe. This appreciation made exports uncompetitive, thus leading to what is termed as Currency Wars.
What was Currency Wars?
It was a term given by Brazilian Finance Minister Guido Mantega, who made headlines when he raised the alarm about a Currency War in September 2010. He claimed that competitive devaluation was being done by various countries, whereby countries who were competing against each other to achieve a relatively low exchange rate for their own currency, to help exports from their domestic industries.
Thus he said that countries were not playing fair, but were cunningly using a pegged exchange rate mechanism rather than market determined exchange rate mechanism.
It must be mentioned that India was not a part of this Currency War and was a vocal critic of the same in the G-20 Meet.
Why all the alarm about QE now?
Some time back the Fed saw that the US economy has finally begun to pick up, and that unemployment is going down with more jobs being added every month, thus it saw its QE programme beginning to have effect.
Since the Fed is the Central Bank of the US and not of the world, it concentrates only on the US economy. Thus ignoring the fact that the US economy in a way dictates global economy.
It (Fed Chairman Ben Barnanke) announced the slow reduction in QE soon in the future seeing the recovery of US economy.
How does that impact India?
Since a lot of the funds of QE were flowing into India, the news of the QE being phased out drove investors to think that since the Indian Economy is slowly failing it would be safer to invest in the rising interest rates and stock market back home. Thus they started withdrawing from the Indian stock markets. Since most of this money was in form of FII’s, we can’t make it stay (hence called Hot Money) and it exited Indian Stock Market, resulting in Stock Markets Crash.
Further since now there are less dollars available in the country due to all the FII’s taking back their investments in USD, a dearth of dollars is felt, thus resulting in depreciation of INR w.r.t. USD. Hence it suddenly went from $1=Rs. 55 to 69.
Also since India’s Imports are much greater than our Exports, we were dependent on this FII investment to cover our import deficit, that is our Current Account Deficit, however since FII are not coming easily now, or are still leaving the government is concerned about how it will make Balance of Payments = 0 (Zero) that is finance Current Account Deficit.
Thus the government is trying to curb imports of unimportant items. However the coming of Raghuram Rajan has been seen by the market as a positive for the failing Indian growth story and hence as per reports there is once again a slow influx of FII.
On September 18th the Fed announced that it would not be tapering off the QE yet, this further gave impetus to FII and market sentiment.
Future?
The future states that sooner or later Fed will erase off QE and we must be prepared now to see a depreciation in rupee once again. To counter this we need to strengthen India’s economic fundamentals further, push for big-ticket reforms, and revive investor and entrepreneur confidence in the economy and the government apparatus.
We cannot be dependent on FII’s forever, rather we need to focus on turning FII into FDI which is more stable. Also we need to drive up our exports especially manufacturing based exports to not be at the mercy of FII for our CAD, rather aim to turn it to CAS (Current Account Surplus) like that of Germany and China, which is based on manufacturing exports.
By:Anant Mittal
References:
1.) The Hindu + Indian Express daily reading
2.) http://www.usatoday.com/story/money/business/2013/09/18/federal-reserve-quantitative-easing/2831097/
3.) http://en.wikipedia.org/wiki/Quantitative_easing
4.) http://en.wikipedia.org/wiki/Currency_war
What is Quantitative Easing?
QE or Quantitative easing was a unconventional policy introduced by the US Federal Reserve (Simply called Fed) which is the Central Bank of USA, like RBI is for India.
Essentially QE implies the policy of the Fed to buy bonds in the open market to essentially ease out liquidity that is to push more money into the market and system. At its latest version i.e. QE3 the Fed was pushing nearly $85 Billion into the market every month through these purchases.
How does QE help? Or what is its main purpose?
QE was a result of the great depression of 2008, by which investor sentiment was much muted globally and especially in the US. Due to the bust (depression) investor sentiment was very low as well as people were not investing in markets, nor taking loans for housing, as well as unemployment was spreading.
To counter this initially the Fed lowered all sorts of rates to bring interest rates down (similar to RBI reducing CRR, SLR, Repo rate etc to reduce interest rate of loans in India). However even after reducing these to the minimum the Fed felt that the investor sentiment was not pushing up and loans were still expensive. So it decided to push money into the hands of the market for use. So basically the Fed hoped to drive up the supply of money available for loans, driving down long-term interest rates so more people would buy and build homes and invest in businesses.
Wouldn’t that extra money result in Inflation?
Technically yes. But practically no. It is true that now there is way more money in the system chasing the same products and so would technically lead to inflation. But we also have to consider the fact that the USD (US Dollar) is a hard currency and freely convertible around the world, and in much demand as it is considered as a stable investment (US is the world’s biggest economy after all). But, instead of all the money staying in the US and in the US market, most of it made its way around the globe to the other economies and countries, one of which was also India.
The people with all the money in US realised that they could not earn much by keeping their money in US Banks or stock market since returns are very low, so why not invest this around the globe in different emerging market stock markets to earn better returns. This resulted in free flow of all the extra money to global markets one of which was India. India’s Sensex and Nifty had been giving very good returns for quite some time and so we saw an influx of FII investment. This helped us not only sustain a larger Current Account Deficit but also made the INR (Indian Rupee) appreciate w.r.t . the USD. A similar event was occurring in nearly all emerging economies around the globe. This appreciation made exports uncompetitive, thus leading to what is termed as Currency Wars.
What was Currency Wars?
It was a term given by Brazilian Finance Minister Guido Mantega, who made headlines when he raised the alarm about a Currency War in September 2010. He claimed that competitive devaluation was being done by various countries, whereby countries who were competing against each other to achieve a relatively low exchange rate for their own currency, to help exports from their domestic industries.
Thus he said that countries were not playing fair, but were cunningly using a pegged exchange rate mechanism rather than market determined exchange rate mechanism.
It must be mentioned that India was not a part of this Currency War and was a vocal critic of the same in the G-20 Meet.
Why all the alarm about QE now?
Some time back the Fed saw that the US economy has finally begun to pick up, and that unemployment is going down with more jobs being added every month, thus it saw its QE programme beginning to have effect.
Since the Fed is the Central Bank of the US and not of the world, it concentrates only on the US economy. Thus ignoring the fact that the US economy in a way dictates global economy.
It (Fed Chairman Ben Barnanke) announced the slow reduction in QE soon in the future seeing the recovery of US economy.
How does that impact India?
Since a lot of the funds of QE were flowing into India, the news of the QE being phased out drove investors to think that since the Indian Economy is slowly failing it would be safer to invest in the rising interest rates and stock market back home. Thus they started withdrawing from the Indian stock markets. Since most of this money was in form of FII’s, we can’t make it stay (hence called Hot Money) and it exited Indian Stock Market, resulting in Stock Markets Crash.
Further since now there are less dollars available in the country due to all the FII’s taking back their investments in USD, a dearth of dollars is felt, thus resulting in depreciation of INR w.r.t. USD. Hence it suddenly went from $1=Rs. 55 to 69.
Also since India’s Imports are much greater than our Exports, we were dependent on this FII investment to cover our import deficit, that is our Current Account Deficit, however since FII are not coming easily now, or are still leaving the government is concerned about how it will make Balance of Payments = 0 (Zero) that is finance Current Account Deficit.
Thus the government is trying to curb imports of unimportant items. However the coming of Raghuram Rajan has been seen by the market as a positive for the failing Indian growth story and hence as per reports there is once again a slow influx of FII.
On September 18th the Fed announced that it would not be tapering off the QE yet, this further gave impetus to FII and market sentiment.
Future?
The future states that sooner or later Fed will erase off QE and we must be prepared now to see a depreciation in rupee once again. To counter this we need to strengthen India’s economic fundamentals further, push for big-ticket reforms, and revive investor and entrepreneur confidence in the economy and the government apparatus.
We cannot be dependent on FII’s forever, rather we need to focus on turning FII into FDI which is more stable. Also we need to drive up our exports especially manufacturing based exports to not be at the mercy of FII for our CAD, rather aim to turn it to CAS (Current Account Surplus) like that of Germany and China, which is based on manufacturing exports.
By:Anant Mittal
References:
1.) The Hindu + Indian Express daily reading
2.) http://www.usatoday.com/story/money/business/2013/09/18/federal-reserve-quantitative-easing/2831097/
3.) http://en.wikipedia.org/wiki/Quantitative_easing
4.) http://en.wikipedia.org/wiki/Currency_war
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