Quantitative Easing is an unconventional type of expansionary monetary policy used by a few Central Banks to stimulate the economy. When the interest rates are zero or negligible then the Central Bank has no option but to increase the money supply by buying the government bonds, corporate bonds, and other financial assets from the economy.
It is at times colloquially used for “printing money.”
The term Quantitative Easing was coined by a Central Bank in a publication by Bank of Japan.
It is a very risky proposition. It can backfire and damage the economy to a greater extent than the intended benefits of it as it did to the Japan economy when it was first used.
The Balance Sheet of the Federal Reserve bank looks somewhat like below post QE2.
For the US, during recession, the interest rates were so low (refer to the above figure) that any decline for expansionary monetary policy was impossible and hence they had to opt for Quantitative Easing.
The first session of QE1 was announced in Nov 2008 and its implementation was completed in March 2009. QE1 amounted to USD 1.7 trillion.
QE2 followed QE1 in November 2010 amounting to USD 600 billion and is supposed to get completed by June 2011.
The impacts of QE2 on the India can be described as follows:
1. Increase in the exchange rates i.e. appreciation of Re:[/b] Due to increase in the money supply in the US, US dollar will depreciate and Indian Rupee will appreciate in value, making the Indian exports expensive and hence, less competitive in the global markets.
2. Higher Capital inflows:[/b] Since the US citizens will have more spending power and more money to invest and India is one of the most desired destinations for profitable investments, India will experience higher FII’s (popularly called the HOT MONEY) and FDI’s.
Also, currently there are not many government interventions on the FII inflows in India and this might lead to severing of the FII policies to control the volatility in the capital markets.
As can be seen in the table below, India is the only nation among the BRIC nations that doesn’t have FX intervention. Also, China has new capital controls in place that India doesn’t and hat might prove damaging to the country.
COUNTRY
FX INTERVENTION
NEW CAPITAL CONTROLS
TAXES ON FOREIGN INVESTMENTS
RAISING RESERVE REQUIREMENT
BRAZIL
YES
NO
YES
NO
RUSSIA
YES
NO
NO
NO
INDIA
NO
NO
NO
YES
CHINA
YES
YES
NO
YES
3. Higher commodity prices:[/b] All commodity prices are valued in US dollars. Due to weakening of USD, the commodities will become dearer to purchase in the Indian markets as well.
4. Upward movement of the stock market indices:[/b] Since the Hot Money will flow in increased amounts in the Indian markets mainly because of the increased money supply in the US and also because of the FII welcoming government policies; there will be an upward movement in the stock markets. It will create wealth for the Indian investors.
5. Increased volatility in the stock market indices[/b]: The Hot Money inflow will lead to high volatility in the stock markets too. The moment these FII’s are withdrawn on account of any global cue or unwelcome event, the markets will plummet and the losses suffered by the domestic investors will be humungous.
6. Increase in inflation in India[/b]: Inflation, on account of both demand side and supply side, will increase in India.
Demand side on account of higher inflows of US dollar in India leading to increase in the spending power of the Indian citizens which will in turn increase the domestic demand in India. The supply side inflation will be in the form of imported inflation and the commodity price increase. India imports approximately 8% of its goods from the US. There will be an increase in the prices of those goods after the release of QE2 leading to increase in the raw materials price, intermediate goods prices, and also the finished goods prices.
Also, India is largely dependent on the other economies of the world for its oil and petrol imports. Those economies too will experience similar price hike leading to increase in the imported inflation in the Indian economy.
The commodity prices too will increase as explained above contributing more to the imported inflation in the country.
7. Asset price bubble in India:[/b] Because of the above mentioned inflation in India, the prices of the assets will go high without any significant increase in their real value leading to the asset price bubble. Unchecked asset price bubble can be dangerous for the economy as this was the cause for the US 2008 recession.
8. Downturn in Manufacturing and Services due to decreased exports:[/b] Since QE2 will lead to increase in the US domestic consumption, it will, therefore, decrease its imports and hence India’s exports. India exports handicrafts, gems and jewelries, textiles, food and beverage items to US along with the IT services. Manufacturing of the above mentioned products will decline in India due to reduction in their exports.
9. Increased Fiscal Deficit[/b]: the Indian fiscal deficit is already an alarming figure. In addition to that, Indian exports becoming globally less competitive due to appreciation of rupee will pose an even higher risk of crossing the 4% of GDP mark.
10. Loss of the outsourcing jobs:[/b] As the US president, Mr. Barack Obama is not favoring the outsourcing of the US jobs to India because of the high unemployment rates; India is going to face a loss of outsourced jobs. Also due to the appreciation of the rupee, the Indian outsourced jobs are going to be more costly to the US companies and Indian jobs may be lost due to that.
Indices
S&P
NIFTY
Volatility Index
Gold
Silver
Crude oil