Mrunal [Economy] Quantitative Easing_ Meaning, Phases, Impacts on Indian Economy, Rupee-Dollar Exchange Rate, Pros & Cons, Positive & Negative Aspects Explained » Mrunal

3/24/2014 Mrunal [Economy] Quantitative Easing: Meaning, phases, Impacts on Indian Economy, Rupee-Dollar Exchange rate, Pros & Cons, Positive & Negative as…

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[Economy] Quantitative Easing: Meaning, phases, Impacts on IndianEconomy, Rupee-Dollar Exchange rate, Pros & Cons, Positive & Negativeaspects explained

1. Prologue

2. Characters in QE movie

3. [Act I] Subprime crisis: toxic assets (2007)

4. [Act II] Quantitative Easing (2008)

5. Why can’t 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 doesn’t require more than 15-20 minutes to understand. IF yourbasics are clear. So make sure you’ve 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) won’t have bigroles in this script. Let me introduce the main protagonists in QE/FT game:

http://mrunal.org/

http://mrunal.org/2014/01/banking-monetary-policy-quantitative-qualitative-tools-applications-limitations-msf-laf-repo-omo-crr-slr-revisited-before-upcoming-urjit-article.html

http://mrunal.org/2012/03/econ-debt-equity.html

http://mrunal.org/2014/01/banking-shadow-banks-wholesale-banks-securitization-functions-features-nachiket-committees-recommendations.html



BenBernanke

when Quantitative easing started, He was the boss of “American RBI”(Chairman of US Federal reserves.) Right now Fed Chairman= JenetYellen.

LeonardoDiCaprio

As such a Hollywood actor. But assume he works in Citigroup’s retailbanking operations. i.e. serving American middleclass and smallbusinessmen.

As such a Hollywood actor. But assume he also works at Citigroup’sInvestment operations i.e.

https://www.flickr.com/photos/97816112@N02/13313317163/



TomCruise

American share market investmentsas foreign institutional investment (FII) in India, China and othercountries.

[Act I] Subprime crisis: toxic assets (2007)

Subprime crisis = American banks gave home loan to people who did not haveaukaat to repay money. These Borrowers stopped paying installment and thebanking 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 deeperunderstanding of what exactly happened in subprime crisis? Especailly: mortgagebased securities / toxic assets.

Prime borrower He has the “aukaat” the repay loan

Sub-prime borrower He doesn’t 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 mortgagetheir property i.e. “if I don’t repay loan, you can take away my house.”Thus, Leo has a big pile of mortgage property files say 100 files x 1 lakh dollarworth 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).

Mortgagebacked

Because they’re “backedup” by those loan-papers. If anything badhappens, Tom can attach those homes, auction then, and return money tothose bond-holders.

Securities

Any piece of paper, that promises to pay some money to someoneat someday = is called security.Shares, bonds, IPOs, debentures….these are all examples of“securities”. Places where they’re bought and sold, we call it“securities market”.

Apart from MBS, they had collateralized debt obligations (CDO), collateralizedloan obligations (CLO) and so on. What are they? Not important for exambecause too old topic. Just know that, lot of “Securities” were created, that werebacked up by those mortgaged home.In USA, (sarkaari) treasury bonds offer interest rate of ~2% Obviously, investorswill be interested in Tom’s MBS (since it offers 4% return).

TomCruise, theinvestmentbanker

Leonardo please get me more loan papers. So, I can printout more MBSsecurities! And our citigroup makes even more profit!

Leonardo,the retailbanker

But I’m already done giving loans to every prime borrower.

TomThen give loans to people who do not have the “aukaat” to repay loans(Subprime borrowers). If they don’t repay, we’ll mortgage property theirproperty. 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 mortagebacked securities (MBS). So, Tom attaches the houses of loan-defaulters. Hetries to auction them, to recover loan money and pay off those stupid investors.But since there is such “oversupply” of mortgaged properties, that real-estatemarket collapses. Imagine fifty Titanics full of onion is dumped at @Mumbaiport- what’ll 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 Icontinue 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 tissuepapers. Because unlike Salman Khan, Tom Cruise cannot keep his “commitment” topay interest to investors.

What do we have now?

1. Mortgaged homes that don’t 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.

Let’s 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 andservices=> Indian, Chinese every exporter / call center also suffers.

2. American FIIs pullout their money from Indian, Chinese, European markets tofill up the losses at home. (Recall, Some Tom Cruise also look after FIIoperations in India, perhaps with help of Anil “Jhakkas” Kapoor.) => even moreslowdown 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 gettingno more money => no business expansion => no new jobs => no salary=> nodemand=> no sales / import.

Why can’t LOW repo rate solve problem?

How can American RBI (US Federal reserve) fix this mess caused by Subprime crisis?One solution will be:

http://mrunal.org/2012/06/econo-greece-exit.html



1. Central Bank should lend (new) money to Retail banks at very cheap interestrate.

2. Then Retail banks will also start giving cheap loans to customers=> businessexpansion => more jobs => more salary => more demand => people buymore=> 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 crudelyput, IF American banks borrowed money from American RBI (US Feds), thenAmerican bank will have to pay 4-6% much interest rate.)

Ben Barnanake indeed reduced the interest rate- close to 0% but it didnot workoutexactly as planned. Why?



Scene #1: NRI Alok Nath’s Business woos

Ben(Recall he’s the Boss of American RBI /Chairman of US Fed).Ok




Bernanke fellas, I’m reducing American federal fund rate to 0.25%. Come on!Take loans from me and distribute among your clients.

Leo(AmericanretailBanker)

I’m going to borrows truckload of dollars from American RBI becauseits available at throwaway prices! Have to pay just 0.25% interest rate.

NRI AlokNath

I want to open a marriage-bureau. Please give me loan.

LeoI’m giving no loans to anyone! I’m sick and tired of loan defaults. I wantto take no more risk.

NRI AlokNath

Lekin Betaa, you’ve borrowed truckload of cash from American RBI(US Feds). What’re you going to do with all that money? …uskaaachaar daaloge kya?

Leo

I’ll do following things with this dollars I got from American RBI

1. I’ll simply invest part of those dollars in US (Sarkaari) Treasurybonds. They are considered the safest investment option. Theyoffer ~2% interest, So my profit is 2-0.25=1.75%. Wellsomething is better than nothing.

2. I’ll give part of those dollars to my buddy Tom Cruise, he’ll investthem in India, China and other markets as “FII”. Perhaps he’ll get~8% return. So, our profit is 8-0.25=7.75%. Again somethingbetter than nothing.

3. Invest part of them in gold4. Redistribute some of the dollars as dividends among my

shareholders. That way price of citigroup shares go up, and mybuddy Tom will again create a new financial product out of that tomake more money!

5. buy off smaller banks, so I get monopoly in the banking business.

NRI AlokNath

Ok, then I’m ready to pay 10% interest. Please give me loan.

LeoSorry uncle-ji. I don’t want to take any risk from any borrower. I alreadyhave lot of toxic assets on my plate. Please, try at some other bank.

NRI AlokNath

(leaves the office, but not without giving aashirwaad to LeonardoDiCaprio).

Scene#2: how to make banks lend money?

Location: Ben Bernanke’s cabin at US federal Reserves (=American RBI)

Ben

(observing the data of industrial output, employment, GDP everything.)Although I’ve 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


http://mrunal.org/2014/03/economy-quantitative-easing-meaning-phases-impacts-indian-economy-rupee-dollar-exchange-rate-pros-cons-positive-negative-as… 10/23

to loan seekers.

Ben(calls up Leo) Man you Stop this nonsense right now, and give loans to thoseneedy American folks.

LeoNot gonna happen. Have lot of toxic assets in my account books. If I give loanto anyone, and he defaults, my Citi group will collapse completely.

Ben

But man, those toxic assets are Tom Cruise’s problem. If I recall correctly,you-Mr.Leonardo-Retail banker- you gave loan files to the “investment” armof Citibank, so Tom must have paid some money to you, right? How comeyour “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 organsunder 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 kitopi uss ke sar pe“). But right now we are in mess due to those “toxicassets”. In short, difficult to pass loans to customers.

Ben

(agitated, but has to find solution quick, before system collapses further)OKLeonardo. 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 THINAIR

So far, Ben agreed to buy off toxic assets of citigroup and other banks. But Bendoesn’t want to waste time “printing” that much paper currency or coins. Hesimply 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) toBen. Ben paid in dollars. So money supply increased (in the sense that now retailBankers have more money to lend to customers.)Does it mean Ben is buying tissue papers in exchange of dollar? (After thoseMBS/Toxic assets are not much money right?) Well Ben hopes that onceeconomy 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 (USfeds) took away their toxic assets

For MCQ: please keep following concepts in mind

Concept#1: QE = NOT OMO

OPEN MARKETOPERATION(OMO)

QUANTITATIVE EASING (QE)

American RBI sellsOR buys governmentsecurities (treasurybonds) from themarket.

American RBI “buys” securities, including those TOXICassets.

If they buy=>money supplyincreased

Since they’re only BUYING=> money supply increased. No“If” no “But”.

If they sell=>money supplydecreased.

QE Cannot decrease money supply. (Well you have to do aseparate thing called “fed tapering”, we’ll see that soon.)For moment, know that QE only INCREASES moneysupply. QE itself cannot decrease money supply.

Concept #2: QE = NOT Monetized Debt

MONETIZING THE DEBT QUANT.EASING (QE)

President Obama wants moredollars to settle his “sarkaari”debt. (fiscal deficit, budget deficitwhatever.)He prints “treasury bonds”=> givesto American RBI (US Feds)e.g 100 Billion $ treasury bondspromising 2% interest rate for tenyears.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 assetsfrom those banks and financialinstitutions like Lehman brothers.[They also bought treasury bondsfrom market, but main focus was toremove "toxic assets" fromsystem].



American RBI takes “securities” fromgovernment and creates more money.

American RBI takes (toxic) “securities”from those bankers, and creates moremoney.

Increases the money supply in thesystem.

same

Anyways, let’s move on: Quantitative Easing was done in three phases, starting from2008.

Click to Enlarge

[PHASE] Quantitative Easing Phase 1

Note: these dates and numbers are not important for exam. I’ve listed them only todemonstrate how events unfolded.

Nov2008

American RBI (US Feds) starts buying mortgage backed securities(MBS) (= those “TOXIC Assets”).Each month $100 billion worth toxic assets bought. [+some treasurybonds]. Collectively, we’ll call them “Securities”Meaning $100 billion new fresh money injected in the system eachmonth.

March2010

Phase 1 of QE ends. US feds bought total $1.7 trillion dollars worthsecurities.




Now Ben waits for result. He thinks his plan is “TOTALLY AWESOME”, thosetoxic assets are out of the banking sector, now those retail banks ought to begiving more loans to Alok Naths => more business expansion =>morejobs=>economy must have bounced back.But when Ben analyses the data, hardly anything has improved! Industrialproduction sucks, unemployment rates are high, GDP growth is low. Whyhaven’t things changed?because retail bankers (Leonardo), is not quickly processing the loanapplications of needy Americans.Leo is happy that his own toxic assets are cleared. But he still doesn’t want totake risk of giving loans to people. He continues investing money in treasurybonds, gold, (+Tom Cruise investing dollars to foreign countries’ sharemarket asFII).

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, sothey 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 theydid not invest it for business expansion in America.Because American juntaa did not have the money to buy their products in largeamount. So these MNCs started exploring Asian market for new customers.They thought “let’s produce phones, camera, laptop and softwares within Asiarather than in USA to save transport costs.”So, MNCs used cheap dollar loans for setting new factories / offices in Asiancountries.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 ofAmerica, Morgan Stanley, Goldman Sach, JP Morgan Chase, Citizenbank etc.They reduced investing in American sharemarket (because nobody buyinganything, companies don’t make large profit, hardly any dividends. So why botherin American sharemarket?)So, these FIIs took Dollars from America and invested inshare/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 emergingmarket 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 andrupee 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 converttheir 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, cheaperthe 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 Dollarweakens:

Implications

Americanimporter

Bad because he has to give more dollars to buy same amt of Indianproducts. []

Americanexporter

Good, because now American products cheaper (for Indian importers)= more demand of American exports.

IndianExporter

Bad

Indianimporter

Good.

Enough of Phase 1, let’s move to




Location: Ben’s 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 BenDone

What did Leonardo do

I bought off Toxicassets (MBS) fromLeo

I used most of those dollars to buy treasury bonds, gold, andforeign investment rather than giving’em as loans to needyAmerican people.

Leo (any American retail bank) is still not processing loan applications quickly.Because there are no “prime” borrowers- left! Almost everyone is broke / subprimethanks to recession. Besides, given the FDI, FII outflows from USA, local companiesare not getting any capital to expand business.

Ben

Let me fix this. I’ll buy off all those treasury bonds from themarket. Then where will Leo (American retail banks) investmenttheir money, huh?They’ll HAVE TO loan money to needy Americans.[To put this intechnical terms- Ben's move will decrease the bond yields forLeo, making it less profitable for him to continue in bond game.Leo will then lend money to needy Americans for better returns.]

November2010

Ben starts buying (long term) US Treasury bonds from market. He plansto 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 givingthem dollars as payment. Thereby increasing money in the system. [What willhappen if Ben started selling treasury bonds? Will money supply increase ordecrease? think about it].anyways, Ben awaits for result. Analyzes the data. There is some improvementbut 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. Dollarremained 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 toIndian market in form of FDI and FII. (That’s why rupee demand was higher, and rupeeremained strong.)


Ben Bernanke’s situation is like that of a senior UPSC player stuck in a viciouscycle of prelim-mains-interview. His best intentions and efforts are not yieldingpositive results. Life is in stalemate. Everyone else is winning and makingmoney.Ben decides to give third attempt with full preparation- he starts buying bothtoxic assets (MBS) as well as Treasury bills. [to increase money supply in themarket, hope at least some of the dollars will reach to needy American folks.]

September2012

Ben starts buying $40 billion worth toxic assets (mortgage backedsecurities/MBS) each monthBen also promised he’ll keep fed fund rate (their repo rate) at 0%till 2015.

December2012

Ben starts buying $45 billion worth Treasury Bills each month. (+40 bnworth MBS)=45+40= total $85 billion dollars injected in the systemevery month= dollar supply increased.

Finally someone (most probably an American civil service aspirant) sends facebookmessage to Ben:

“Dear Sir-ji,

For how long, will you keep throwing more and more money like a defeatedgambler?

For how long, will you keep creating more and more (electronic) dollars out of thinair and let them vanish in India, China and other third world countries?

Man I’m 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 stopQE at some point.”

When will Ben stop QE?



target Ben’s thought process

Inflation 2.5%

If inflation gets higher than 2.5%, I’ll stop QE. Because(moderate) rise in inflation =juntaa is buying more (hence thedemand side inflation)= economy has recovered. And sinceeconomy has recovered, QE should be stopped.

Unemployment6.5%

If unemployment get lower than 6.5%, I’ll stop QE. Because lessunemployment = 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 hasto slowly reduce it and then stop, otherwise negative consequences in theeconomy.When Ben starts reducing QE, we call it “Fed Tapering”. More details in nextarticle.

Summary of Quantitative Easing

1. Quantitative easing [QE] was a novel expansionist monetary policy to contain thenegative impact of subprime crisis and put American economy back on growthtrack. [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) toincrease 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 Americanbanks- stimulating them to lend more toAmerican folks.

Banks did not lend all ofthe dollars to Americanfolks.

More dollars= Easier access to credit /capital => business expansion=> morejobs=> more demand (Because salary inhand) => sales increased, economy booms.

Within USA, It didn’tstimulate as mucheconomic growth as Benhad hoped.Most of the new jobs werecreated in foreign



countries, rather than inUSA.

Ben’s (Sarkaari) Treasury Bond buyingprogram: now investors had to look out fornew avenues to pump money i.e. corporatebonds, equities, IPOs= more capital forAmerican businessman=business expansion=more jobs=growth.

Not really. Once investorswere forced out of treasurybond game, they startedputting money in gold.As a result: within 2008 to11, gold prices soaredfrom ~850$ to ~1900dollars! [= gold expensiveeven for India= our Currentaccount deficit increased.]

Dollar weakened against foreign currencies,benefiting the American exporters.

American exporterscouldnot get easy loansfrom banks to expandproduction. => still couldnot compete with Asiangiants pricewise.Besides, Weak dollar= badFor American importers.=> higher Current Accountdeficit for USA.

–

Big banks/financialinstitutions used thesedollars to buy off smallloss making banks. Thusbanking sector becameoligopoly.Today largest 0.2% ofAmerican banks controlmore than 70% of bankassets 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.He’ll pump money into Indian share market. Say in ABC Infra. Company. Tomkeeps 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 pricewill rise to 2000 rupees next week.But within a week, Tom Cruise (FII)’s expert tell him to invest in Xyz ChineseCompany’s shares for better returns. For these billion dollar FIIs, even returndifference of 2% will translates to millions. Hence they move money from onenation to another at rapid speed.So Tom immediately sells ABC infra shares to pullout his (rupee) money, getsthem 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 goneup 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 acountry => exchange rates become volatile. (After all, its dollar vs rupee supplydemand.)Although QE = dollar supply increased = rupee should strengthen. But given theabove nuisance of FII “Hot money”, rupee would keep fluctuating. (and we’ve toblame 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 importernor for exporter because they cannot decide their calculations about input cost,taxes, profit margin, everything gets messed up. Long term business planning ismission impossible (thanks to Tom cruise this time!).Then RBI has to intervene to keep the exchange rates stable. How? RecallApples, fridges and Urjit Patel click me

Anyways, let’s check positive and negative impact of US Quantitative easing on Indianeconomy.

POSITIVE NEGATIVE

During the initial phase:More dollarsupply=>More FII, FDIinvestment

FII investment were mostly “hot money” –they’d pull out from our market, as soon asthey saw even slightly better returns inanother country. = lot of ups and downs,volatile share market.

http://mrunal.org/2014/02/economy-rbi-urjit-patel-committee-4-cpi-nominal-anchor-multiple-indicator-monetary-policy-framework-reforms-part-1-of-2.html#exchange



This helped in businessexpansion= more jobs,more production moreGDP growth.

FDI: in the early phase [2008-10], we hadnot relaxed FDI rules. So we couldn’t attractas much FDI (From USA) like otheremerging economies.

—

In the later part of QE era (mid 2012onwards), all the positive factors were lostbecause of domestic inflation and policyparalysis. Leading to decline in FDI/FII(compared to what we deserved)

Rupee strengthened againstdollar. (e.g $1=Rs.50to$1=Rs.40). Good forimporters.

Bad for exporters and call centersPlus, they were already seeing less ordersdue to recession like situation in US and EUduring this era. So, rupee strengthening =adding insult to their injury.

2012: FII injected ~18 billionUSD in Indian market. (That toodespite policy paralysis, GAARcontroversy.)

They would have invested even more if there wasno policy paralysis / GAAR controversy.

Cheaper dollar helped Indiancorporates to borrow fromabroad.

India’s external debt increased (especially whenlater 1$=became close to Rs.65)

RBI’s forex reserves increased.Because cheap dollars, RBIcould collect more by sellingits rupee reserves in exchangeof dollars.

Forex reserve increased only for the first twoyears of QE. Later hardly any improvement, in factforex reserve declined in 2013 (when RBI tried tostop rupee downfall by selling its own dollars inmarket)

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 andEconomy.

URL to article: http://mrunal.org/2014/03/economy-quantitative-easing-meaning-phases-impacts-indian-economy-rupee-dollar-exchange-rate-pros-cons-positive-negative-aspects-explained.html

Posted By Mrunal On 22/03/2014 @ 00:36 In the category Economy

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Mrunal [Economy] Quantitative Easing_ Meaning, Phases, Impacts on Indian Economy, Rupee-Dollar Exchange Rate, Pros & Cons, Positive & Negative Aspects Explained » Mrunal

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