Explained - Quantitative Easing - Meaning, Mechanism, Implication

7/29/2014 Explained: Quantitative Easing- Meaning,Mechanism,Implication
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[Economy] Quantitative Easing: Meaning, phases, Impacts on Indian Economy, Rupee-Dollar
Exchange rate, Pros & Cons, Positive & Negative aspects explained
CSAT

1. Prologue
2. Characters in QE movie
3. [Act I] Subprime crisis: toxic assets
(2007)
4. [Act II] Quantitative Easing (2008)
5. Why cant LOW repo rate solve
problem?
6. Quantitative Easing: Electronic Money OUT OF THIN AIR
1. Concept#1: QE = NOT OMO
2. Concept #2: QE = NOT Monetized Debt
7. [PHASE] Quantitative Easing Phase 1
1. QE PH1: Impact on FDI / FII
2. QE PH1: Impact on Exchange Rates
10. When will Ben stop QE?
11. Summary of Quantitative Easing
1. QE: Good or Bad? (American point of view)
2. QE: Good or Bad? (Indian point of view)
Prologue
Next article is Fed tapering and its impact on Indian Economy.
But to learn fed tapering, first we need to understand Quantitative easing (QE) AND its impact
on Indian economy.
Topic itself doesnt require more than 15-20 minutes to understand. IF your basics are clear. So
make sure youve read previous articles:
1. RBI monetary policy: quantitative and qualitative tools. Click me
2. Debt vs equity click me
3. Securitization & Shadow banks click me
Characters in QE movie
Since this is American story, our routine characters (Mohan/Chindu) wont have big roles in this
script. Let me introduce the main protagonists in QE/FT game:

days
25

hrs
11

mi ns
23

sec.
06
What's New? ?
Ben
Bernanke
when Quantitative easing started, He was the boss of
American RBI (Chairman of US Federal reserves.)
Right now Fed Chairman= Jenet Yellen.
Leonardo
DiCaprio
As such a Hollywood actor. But assume he works in
Citigroups retail banking operations. i.e. serving
American middleclass and small businessmen.
Tom
As such a Hollywood actor. But assume he also
works at Citigroups Investment operations i.e.
Cruise American share market investments
as foreign institutional investment (FII) in India,
China and other countries.
[Act I] Subprime crisis: toxic assets (2007)
Subprime crisis = American banks gave home loan to people who did not have aukaat to repay
money. These Borrowers stopped paying installment and the banking system collapses.
^this is the crudest, simplest explanation. Most of you know this already.
But to understand Quantitative Easing and Fed Tapering, we need a little deeper understanding
of what exactly happened in subprime crisis? Especailly: mortgage based securities / toxic
assets.
Prime borrower He has the aukaat the repay loan
Sub-prime borrower He doesnt have the aukaat to repay loan.
Initially, American Retail Banker Mr.Leonardo only lends money to prime borrowers. And for
repayment-guarantee, he orders customers to mortgage their property i.e. if I dont repay
loan, you can take away my house.
Thus, Leo has a big pile of mortgage property files say 100 files x 1 lakh dollar worth property
each = $100 lakh.
He gives these files to Tom Cruise, the investment banker.
Tom prints out 10 lakh bonds, worth $10 each, offering say 4% interest rate. Sells them at
American market. We call them mortgaged backed securities (MBS).
Mortgage
backed
Because theyre backedup by those loan-papers. If
anything bad happens, Tom can attach those homes,
auction then, and return money to those bond-
holders.
Securities
Any piece of paper, that promises to pay some
money to someone at someday = is called
security.
Shares, bonds, IPOs, debentures.these are all
examples of securities. Places where theyre
bought and sold, we call it securities market.
Apart from MBS, they had collateralized debt obligations (CDO), collateralized loan obligations
(CLO) and so on. What are they? Not important for exam because too old topic. Just know that,
lot of Securities were created, that were backed up by those mortgaged home.
In USA, (sarkaari) treasury bonds offer interest rate of ~2% Obviously, investors will be
interested in Toms MBS (since it offers 4% return).
Tom
Cruise,
the
investment
banker
Leonardo please get me more loan papers. So, I
can printout more MBS securities! And our citigroup
makes even more profit!
Leonardo,
the retail
banker
But Im already done giving loans to every prime
borrower.
Tom
Then give loans to people who do not have the
aukaat to repay loans (Subprime borrowers). If they
dont repay, well mortgage property their property. In
short, our gameplan is safe and secure. Nothing to
worry.
Leo Starts giving loan to sub-prime borrowers.
Later, one by one, sub-prime borrowers stop EMI payments.
But, Tom still has to pay 4% interest to those investors for those mortage backed securities
(MBS). So, Tom attaches the houses of loan-defaulters. He tries to auction them, to recover
loan money and pay off those stupid investors.
But since there is such oversupply of mortgaged properties, that real-estate market collapses.
Imagine fifty Titanics full of onion is dumped at @Mumbai port- whatll be the price then?
Same is the situation in American real-estate sector. Original loan amount was $1 lakh but right
now, noone is ready to pay even $30,000 for the same home.
As a result, even HONEST (prime) borrowers feel cheated. Why should I continue to repay my
loan, IF my house is not even worth 30000 dollars? So, he also stops giving EMI. => more
default=> more crash @real-estate.
The Fall of MBS
Thus, within overnight, mortgage backed securities (MBS) have become fancy tissue papers.
Because unlike Salman Khan, Tom Cruise cannot keep his commitment to pay interest to
investors.
What do we have now?
1. Mortgaged homes that dont fetch good prices in auction.
2. Mortgage backed securities (MBS), collateralized debt obligations (CDO) and other fancy
papers that commend no price in the sharemarket / securities market.
Lets collectively call them TOXIC Assets. (In India, we may have called them NPA, non-
performing assets.)
Consequences on World economy
1. Due to these toxic assets, lot of investors money stuck. Share market collapses. Businesses
collapse. Less demand => less jobs => less import of goods and services=> Indian, Chinese
every exporter / call center also suffers.
2. American FIIs pullout their money from Indian, Chinese, European markets to fill up the losses
at home. (Recall, Some Tom Cruise also look after FII operations in India, perhaps with help of
Anil Jhakkas Kapoor.) => even more slowdown in global economy.
3. This also acts as catalyst in PIGS crisis / Greece Sovereign debt crisis (click me)= even more
slowdown in world economy.
[Act II] Quantitative Easing (2008)
So far
American economy collapsed thanks to subprime crisis.
Banking / financial institutions (like CITIGROUP) have truckload of TOXIC assets. (or NPA)
Investors money is stuck.
Banks are not giving loans to new customers (fearing more toxic assets and loan-default). So,
whether its prime borrower or sub-prim borrower- no body getting no more money => no
business expansion => no new jobs => no salary=> no demand=> no sales / import.
Why cant LOW repo rate solve problem?
How can American RBI (US Federal reserve) fix this mess caused by Subprime crisis? One
solution will be:
1. Central Bank should lend (new) money to Retail banks at very cheap interest rate.
2. Then Retail banks will also start giving cheap loans to customers=> business expansion =>
more jobs => more salary => more demand => people buy more=> economy back on track.
3. Indian RBI uses Repo rate for this. [click me for more]
4. American RBI uses Federal Fund rate for this. [although mechanism bit different but not really
important for exam. So let's not waste time here]
In the 90s, American federal fund rate = used to be in the range of 4-6%. (To crudely put, IF
American banks borrowed money from American RBI (US Feds), then American bank will have to
pay 4-6% much interest rate.)
Ben Barnanake indeed reduced the interest rate- close to 0% but it didnot workout exactly as
planned. Why?
Scene #1: NRI Alok Naths Business woos
Ben
Bernanke
(Recall hes the Boss of American RBI /Chairman of
US Fed).Ok fellas, Im reducing American federal
fund rate to 0.25%. Come on! Take loans from me
and distribute among your clients.
Leo
(American
retail
Banker)
Im going to borrows truckload of dollars from
American RBI because its available at throwaway
prices! Have to pay just 0.25% interest rate.
NRI Alok
Nath
I want to open a marriage-bureau. Please give me
loan.
Leo
Im giving no loans to anyone! Im sick and tired of
loan defaults. I want to take no more risk.
NRI Alok
Nath
Lekin Betaa, youve borrowed truckload of cash from
American RBI (US Feds). Whatre you going to do
with all that money? uskaa achaar daaloge kya?
Leo
Ill do following things with this dollars I got from
American RBI
1. Ill simply invest part of those dollars in US
(Sarkaari) Treasury bonds. They are considered
the safest investment option. They offer ~2%
interest, So my profit is 2-0.25=1.75%. Well
something is better than nothing.
2. Ill give part of those dollars to my buddy Tom
Cruise, hell invest them in India, China and other
markets as FII. Perhaps hell get ~8% return.
So, our profit is 8-0.25=7.75%. Again something
better than nothing.
3. Invest part of them in gold
4. Redistribute some of the dollars as dividends
among my shareholders. That way price of
citigroup shares go up, and my buddy Tom will
again create a new financial product out of that
to make more money!
5. buy off smaller banks, so I get monopoly in the
banking business.
NRI Alok
Nath
Ok, then Im ready to pay 10% interest. Please give
me loan.
Sorry uncle-ji. I dont want to take any risk from any
borrower. I already have lot of toxic assets on my
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Leo plate. Please, try at some other bank.
NRI Alok
Nath
(leaves the office, but not without givingaashirwaad to
Leonardo DiCaprio).
Scene#2: how to make banks lend money?
Location: Ben Bernankes cabin at US federal Reserves (=American RBI)
Ben
(observing the data of industrial output, employment, GDP
everything. )Although Ive reduced the interest rates, Why is
the economy not improving, why is there no business
expansion? Why are no new jobs created?
Aha.Leonardo DiCaprio is the culprit. He is not passing
on my cheap dollars to loan seekers.
Ben
(calls up Leo) Man you Stop this nonsense right now, and
give loans to those needy American folks.
Leo
Not gonna happen. Have lot of toxic assets in my account
books. If I give loan to anyone, and he defaults, my Citi
group will collapse completely.
Ben
But man, those toxic assets are Tom Cruises problem. If I
recall correctly, you-Mr.Leonardo-Retail banker- you gave
loan files to the investment arm of Citibank, so Tom must
have paid some money to you, right? How come your
department has toxic assets?
Leo
You see we are not a simple bank. We are a Financial
institution. Some of our organs under jurisdiction of
American RBI, some organs under regulation of
American SEBI, with operations in India, China etc.
under jurisdiction of their RBIs and their SEBIs.
Its lot more complicated financial jugglery than you can
fathom (iss ki topi uss ke sar pe). But right now we
are in mess due to those toxic assets. In short, difficult
to pass loans to customers.
Ben
(agitated, but has to find solution quick, before system
collapses further)OK Leonardo. How about I buy the toxic
assets Citigroup and all other financialjugglers institutions.
Then, will you give loans to those needy customers?
Please?
Leo Fair enough.
Quantitative Easing: Electronic Money OUT OF THIN AIR
So far, Ben agreed to buy off toxic assets of citigroup and other banks. But Ben doesnt want to
waste time printing that much paper currency or coins. He simply types an amount in his
super computer at US feds office. And that much (electronic) dollars are automatically created
in the banking system.
When Leonardo (and other retail bankers) sell their TOXIC ASSETS to Ben, Mr.Ben will
transfer dollar in their account via netbanking.
ok, so, what is happening here? Money supply increased or decreased?
Ans. Increased.
Because Charlie and other retail bankers sold their tomatoes (toxic assets) to Ben. Ben paid in
dollars. So money supply increased (in the sense that now retail Bankers have more money to
lend to customers.)
Does it mean Ben is buying tissue papers in exchange of dollar? (After those MBS/Toxic assets
are not much money right?) Well Ben hopes that once economy recovers, those mortgaged
houses could fetch higher prices in auction, then he can sell MBS to private investors and
recover the money.
This is called quantitative easing
Quantitative Quantity of money increased.
Easing
stress / tension of Banks decreased. because
American RBI (US feds) took away their toxic
assets
For MCQ: please keep following concepts in mind
Concept#1: QE = NOT OMO
OPEN MARKET
OPERATION
(OMO)
QUANTITATIVE EASING (QE)
American RBI
sells OR buys
government
securities
(treasury bonds)
from the market.
American RBI buys securities, including
those TOXIC assets.
If they buy=>
money
supply
increased
Since theyre only BUYING=> money supply
increased. No If no But.
If they sell=>
money
supply
decreased.
QE Cannot decrease money supply. (Well you
have to do a separate thing called fed
tapering, well see that soon.) For moment,
know that QE only INCREASES money
supply. QE itself cannot decrease money
supply.
Concept #2: QE = NOT Monetized Debt
MONETIZING THE DEBT QUANT.EASING (QE)
President Obama wants
more dollars to settle his
sarkaari debt. (fiscal
deficit, budget deficit
whatever.)
He prints treasury
bonds=> gives to
American RBI (US Feds)
e.g 100 Billion $ treasury
bonds promising 2%
interest rate for ten years.
Then American RBI (US
feds), prints that much
dollar Currency and gives
suitcases to Obama.
This is called Monetizing
the debt.
American RBI buying toxic
assets from those banks
and financial institutions
like Lehman brothers.
[They also bought treasury
bonds from market, but
main focus was to remove
"toxic assets" from system].
American RBI takes
securities from government
and creates more money.
American RBI takes (toxic)
securities from those bankers,
and creates more money.
Increases the money supply in
the system.
same
Anyways, lets move on: Quantitative Easing was done in three phases, starting from 2008.
Click to Enlarge
[PHASE] Quantitative Easing Phase 1
Note: these dates and numbers are not important for exam. Ive listed them only to demonstrate how
events unfolded.
Nov
2008
American RBI (US Feds) starts buying mortgage
backed securities (MBS) (= those TOXIC Assets).
Each month $100 billion worth toxic assets bought.
[+some treasury bonds]. Collectively, well call them
Securities
Meaning $100 billion new fresh money injected in the
system each month.
March
2010
Phase 1 of QE ends. US feds bought total $1.7 trillion
dollars worth securities.
Now Ben waits for result. He thinks his plan is TOTALLY AWESOME, those toxic assets are
out of the banking sector, now those retail banks ought to be giving more loans to Alok Naths
=> more business expansion =>more jobs=>economy must have bounced back.
But when Ben analyses the data, hardly anything has improved! Industrial production sucks,
unemployment rates are high, GDP growth is low. Why havent things changed?
because retail bankers (Leonardo), is not quickly processing the loan applications of needy
Americans.
Leo is happy that his own toxic assets are cleared. But he still doesnt want to take risk of giving
loans to people. He continues investing money in treasury bonds, gold, (+Tom Cruise investing
dollars to foreign countries sharemarket as FII).
QE PH1: Impact on FDI / FII
Quantitative Easing => Dollar supply increased in American market.
Ben Bernanke hoped these dollars will be given as loans to American people, so they can start
new business, create more jobs, produce more goods and services..
But lot of these dollars did not reach the hands of common Americans.
#1: FDI inflows increased in emerging economies
Big businesses like Apple, Microsoft, wallmart=> They got cheap loans, but they did not invest it
for business expansion in America.
Because American juntaa did not have the money to buy their products in large amount. So
these MNCs started exploring Asian market for new customers.
They thought lets produce phones, camera, laptop and softwares within Asia rather than in
USA to save transport costs.
So, MNCs used cheap dollar loans for setting new factories / offices in Asian countries.
Result: FDI inflows increased for Asian countries including India, China.
#2: FII inflows increased in emerging economies
MNC type financial institutions (FI) such as Deutsche Securities, Bank of America, Morgan
Stanley, Goldman Sach, JP Morgan Chase, Citizenbank etc.
They reduced investing in American sharemarket (because nobody buying anything,
companies dont make large profit, hardly any dividends. So why bother in American
sharemarket?)
So, these FIIs took Dollars from America and invested in share/bond/equities/IPO in India-China
and other emerging economies.
Result FII inflows also increased in the emerging economies.
QE PH1: Impact on Exchange Rates
So far, we know Quantitative easing increased the FDI, FII inflows in emerging market
economies.
what could have happened to exchange rates? Did Rupee strengthen or weaken? Did Dollar
strengthen or weaken?
Ans. Since dollar supply increased (compared to rupee), then Dollar weakens and rupee
strengthen. Observe.
Month 1$=__ rupees 1 Rs.=___ $
Jan 2009 50 0.02
October 2009 46 0.0217
March 2010 (when QE1
ended)
44 0.0227
Meaning
Dollar
weakened
Rupee
strengthened
So what do you see? IS Rupee strengthening or weakening?
Ans. Rupee Strengths, Dollar weakens.
Why? Because if those FDI/FII players want to invest in India, they need to convert their Dollars into
rupees.
Imagine dollars are apples.
Prices of apple vs Rupee are decided by laws of supply and demand.
If few apples=> each apple will sell for 50 rupees.
If more apples=> each apple will sell for 44 rupees. (more the quantity, cheaper the product.)
Same happened with all major currencies in world yen, yuan, euro, pound, rupee they
strengthened while dollar Weakened.
Is it good or bad?
Ans. Depends
If Dollar
weakens:
Implications
American
importer
Bad because he has to give more dollars to buy
same amt of Indian products. []
American
exporter
Good, because now American products cheaper (for
Indian importers) = more demand of American
exports.
Indian
Exporter
Bad
Indian
importer
Good.
Enough of Phase 1, lets move to
Location: Bens cabin @American RBI office (i.e. US Federal reserve)
Ben check data on GDP, loan disbursement, industrial production, inflation, unemployment etc.
Hardly anything has improved.
What has
Ben Done
What did Leonardo do
I bought off
Toxic assets
(MBS) from
Leo
I used most of those dollars to buy treasury
bonds, gold, and foreign investment rather than
givingem as loans to needy American people.
Leo (any American retail bank) is still not processing loan applications quickly. Because there are
no prime borrowers- left! Almost everyone is broke / subprime thanks to recession. Besides,
given the FDI, FII outflows from USA, local companies are not getting any capital to expand
business.
Ben
Let me fix this. Ill buy off all those treasury
bonds from the market. Then where will Leo
(American retail banks) investment their money,
huh?
Theyll HAVE TO loan money to needy
Americans.[To put this in technical terms- Ben's
move will decrease the bond yields for Leo,
making it less profitable for him to continue in
bond game. Leo will then lend money to needy
Americans for better returns.]
November
2010
Ben starts buying (long term) US Treasury bonds
from market. He plans to buy total $600 billion
dollars worth bonds during QE phase 2.
June
2011
The QE2 phase ends.
Is money supply increased or decreased?
Increased. Because Ben is buying sarkaari bonds from investors, and giving them dollars as
payment. Thereby increasing money in the system. [What will happen if Ben started selling
treasury bonds? Will money supply increase or decrease? think about it].
anyways, Ben awaits for result. Analyzes the data. There is some improvement but lot needs to
be done. So, later he starts third phase.
Effect of QE2
Again same as last time- FDI, FII inflow increased in emerging economies. Dollar remained weak
compared to foreign currencies.
2010-11 $1=__ Rs.
Nov 2010 44
March 2011 45
June 2011 45.3
You can see rupee almost steady at around 44-45. Meaning dollar kept coming to Indian market in
form of FDI and FII. (Thats why rupee demand was higher, and rupee remained strong.)
Ben Bernankes situation is like that of a senior UPSC player stuck in a vicious cycle of prelim-
mains-interview. His best intentions and efforts are not yielding positive results. Life is in
stalemate. Everyone else is winning and making money.
Ben decides to give third attempt with full preparation- he starts buying both toxic assets (MBS)
as well as Treasury bills. [to increase money supply in the market, hope at least some of the
dollars will reach to needy American folks.]
September
2012
Ben starts buying $40 billion worth toxic assets
(mortgage backed securities/MBS) each month
Ben also promised hell keep fed fund rate
(their repo rate) at 0% till 2015.
December
2012
Ben starts buying $45 billion worth Treasury Bills
each month. (+40 bn worth MBS)=45+40= total $85
billion dollars injected in the system every month=
dollar supply increased.
Finally someone (most probably an American civil service aspirant) sends facebook message to
Ben:
Dear Sir-ji,
For how long, will you keep throwing more and more money like a defeated gambler?
For how long, will you keep creating more and more (electronic) dollars out of thin air and let them
vanish in India, China and other third world countries?
Man Im sick and tired of mugging up your QE data for stupid competitive exams. Please stop this
nonsense ASAP.
Sincerely,
A concerned American citizen.
Ben finally gains some enlightenment, I cannot go on like this forever! Have to stop QE at some
point.
When will Ben stop QE?
target Bens thought process
Inflation 2.5%
If inflation gets higher than 2.5%, Ill stop QE.
Because (moderate) rise in inflation =juntaa is
buying more (hence the demand side inflation)=
economy has recovered. And since economy
has recovered, QE should be stopped.
Unemployment
6.5%
If unemployment get lower than 6.5%, Ill stop
QE. Because less unemployment = definitely
there is business expansion = American
economy Has recovered. No more need for QE.
Meaning EITHER inflation >2.5% OR unemployment <6.5%, then I stop QE. Ben had decided
these targets in December 2012.
But Ben cannot suddenly stop Quantitative Easing on one fine morning. He has to slowly
reduce it and then stop, otherwise negative consequences in the economy.
When Ben starts reducing QE, we call it Fed Tapering. More details in next article.
Summary of Quantitative Easing
1. Quantitative easing [QE] was a novel expansionist monetary policy to contain the negative
impact of subprime crisis and put American economy back on growth track. [expansionist
because money supply increased]
2. Under QE, US Federal reserve (Feds), started purchasing both toxic assets (mortgage backed
securities /MBS) and gilt edged securities (treasury bonds) to increase dollar liquidity in the
market.
3. QE was started in 2008, was carried out in three phases.
4. US feds have decided that QE will be stopped when EITHER unemployment rate is less than
6.5% OR inflation is higher than 2.5%.
5. QE will not be stopped suddenly. QE will be reduced gradually. This gradual reduction in
Quantiative Easing / bond buying pogrom is called Fed Tapering.
QE: Good or Bad? (American point of view)
POSITIVE NEGATIVE
Removed toxic assets from
American banks- stimulating them
to lend more to American folks.
Banks did not lend
all of the dollars to
American folks.
More dollars= Easier access to
credit / capital => business
expansion=> more jobs=> more
demand (Because salary in hand)
=> sales increased, economy
booms.
Within USA, It didnt
stimulate as much
economic growth as
Ben had hoped.
Most of the new jobs
were created in
foreign countries,
rather than in USA.
Bens (Sarkaari) Treasury Bond
buying program: now investors
had to look out for new avenues to
pump money i.e. corporate
bonds, equities, IPOs= more
capital for American
businessman=business
expansion =more jobs=growth.
Not really. Once
investors were
forced out of
treasury bond game,
they started putting
money in gold.
As a result: within
2008 to 11, gold
prices soared from
~850$ to ~1900
dollars! [= gold
expensive even for
India= our Current
account deficit
increased.]
Dollar weakened against foreign
currencies, benefiting the American
exporters.
American exporters
couldnot get easy
loans from banks to
expand production.
=> still could not
compete with Asian
giants pricewise.
Besides, Weak
dollar= bad For
American importers.
=> higher Current
Account deficit for
USA.
Big banks/financial
institutions used
these dollars to buy
off small loss
making banks. Thus
banking sector
became oligopoly.
Today largest 0.2%
of American banks
control more than
70% of bank assets
in America.
QE: Good or Bad? (Indian point of view)
Two main reasons why it was (mostly) bad
#1: Nuisance Hot Money
Recall Tom Cruise, the investment banker / FII.
Hell pump money into Indian share market. Say in ABC Infra. Company. Tom keeps buying and
buying= Prices of the shares go higher and higher -1000, 1200, 1500..(supply, demand and
speculation).
The desi investors (aam admi), also buy those shares @1500, hoping its price will rise to 2000
rupees next week.
But within a week, Tom Cruise (FII)s expert tell him to invest in Xyz Chinese Companys
shares for better returns. For these billion dollar FIIs, even return difference of 2% will translates
to millions. Hence they move money from one nation to another at rapid speed.
So Tom immediately sells ABC infra shares to pullout his (rupee) money, gets them converted
to yuan and buys Chinese company shares.
Then ABC shares suddenly collapse- barely 700-800 rupees. (supply-demand-speculation)
As a result, desi investors (aam admi)s money is lost [because they had bought @1500].
This nuisance of FII hotmoney= one of the biggest reason why sharemarket has gone up and down
in a volatile manner in recent years.
#2: Headache for Exporters, Importers & RBI
In above point, we saw how FII rapidly inject and pull out their money from a country =>
exchange rates become volatile. (After all, its dollar vs rupee supply demand.)
Although QE = dollar supply increased = rupee should strengthen. But given the above
nuisance of FII Hot money, rupee would keep fluctuating. (and weve to blame Mohan also-
because policy paralysis= provokes FIIs to pullout money.)
when exchange rates keep fluctuating (say today 1$=55 Rs. and tomorrow $1=65 Rs.), this is
not conductive for business planning- neither for importer nor for exporter because they cannot
decide their calculations about input cost, taxes, profit margin, everything gets messed up.
Long term business planning is mission impossible (thanks to Tom cruise this time!).
Then RBI has to intervene to keep the exchange rates stable. How? Recall Apples, fridges and
Urjit Patel click me
Anyways, lets check positive and negative impact of US Quantitative easing on Indian economy.
POSITIVE NEGATIVE
During the initial
phase: More dollar
supply=>More FII,
FDI investment
This helped in
business
expansion= more
jobs, more
production more
GDP growth.
FII investment were mostly hot
money theyd pull out from our
market, as soon as they saw even
slightly better returns in another
country. = lot of ups and downs,
volatile share market.
FDI: in the early phase [2008-10],
we had not relaxed FDI rules. So
we couldnt attract as much FDI
(From USA) like other emerging
economies.
In the later part of QE era (mid

2012 onwards), all the positive
factors were lost because of
domestic inflation and policy
paralysis. Leading to decline in
FDI/FII (compared to what we
deserved)
Rupee strengthened
against dollar. (e.g
$1=Rs.50 to$1=Rs.40).
Good for importers.
Bad for exporters and call centers
Plus, they were already seeing
less orders due to recession like
situation in US and EU during this
era. So, rupee strengthening =
adding insult to their injury.
2012: FII injected ~18
billion USD in Indian
market. (That too
despite policy paralysis,
GAAR controversy.)
They would have invested even more if
there was no policy paralysis / GAAR
controversy.
Cheaper dollar helped
Indian corporates to
borrow from abroad.
Indias external debt increased
(especially when later 1$=became
close to Rs.65)
RBIs forex reserves
increased. Because
cheap dollars, RBI could
collect more by selling
its rupee reserves in
exchange of dollars.
Forex reserve increased only for the
first two years of QE. Later hardly any
improvement, in fact forex reserve
declined in 2013 (when RBI tried to
stop rupee downfall by selling its own
dollars in market)
With inputs from Mr.Shivaram G.
Mock questions, after we are done with fed tapering in next article.
Visit Mrunal.org/Economy For more on Money, Banking, Finance, Taxation and Economy.

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7/29/2014 Explained: Quantitative Easing- Meaning,Mechanism,Implication

In the later part of QE era (mid

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