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.
Wouldnt 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 worlds
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. Indias 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 FIIs, we cant 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 FIIs 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 Indias 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 Indias
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 FIIs 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-quantitativeeasing/2831097/
3.) http://en.wikipedia.org/wiki/Quantitative_easing
4.) http://en.wikipedia.org/wiki/Currency_war