By Arpit Goel
In the past few months, quantitative easing has become one of the most talked about investment terms of the country. Whether it is the falling value of the rupee, or the increasing current account deficit, each and every thing is linked to quantitative easing (QE). Now, what exactly is QE Its an unconventional monetary policy used by Central Banks to stimulate the economy, when the standard monetary policy has become ineffective. It basically implies that Central Banks buy long term bonds (debt) from commercial banks in return for money. It works on the model of OMO’s (open market operations), dealing in long term securities, thereby helping in lowering long term interest rates out on the yield curve.
It started in 2008, when there was liquidity crisis in the US; the Federal Reserve came up with an option of QE and named it QE1. In late November 2008, they started buying $600 billion of mortgage-backed securities, and by March 2009, it held $1.75 trillion of bank debt, mortgage-backed securities, and Treasury notes; this amount reached a peak of $2.1 trillion in June 2010. Further purchases were halted as the economy started to improve, but resumed in August 2010 when the Fed decided that the economy was not growing robustly. Their revised goal began to keep holdings at $2.054 trillion and to maintain that level, they bought $30 billion in two-to-ten year Treasury notes every month. In November 2010, they began with the second round of this policy, and was buying $600 billion of Treasury securities by the end of the second quarter of 2011. By the end of 2012, the Fed was buying at the rate of $85 billion per month. On June 19th 2013, Ben Bernanke (Chairman of the Federal Reserve at the time) said that he would taper down this buying of bonds by the end of December 2013, and would probably stop it by the mid 2014. While Bernanke did not announce an interest rate hike, he suggested that there would be an increase in inflation by a 2% target rate, and a decrease in unemployment by 6.5% in the US.
Now, how does it affect the Indian market, and the Indian rupee. After the Bernanke statement, Dow Jones dropped by 659 points, and there were heavy withdrawals in the US market because the Federal Reserve started tapping bonds there. Since there is an inverse relationship between bonds and interest, the interest rates in the US rose, resulting in foreign investors withdrawing their investments from Indian markets and investing there. This led to a 500 point dip in the Sensex on the very first day. There was a huge currency movement in our foreign reserve, which led to the depreciation of the Indian rupee, which stopped at Rs. 69.24- its all time low. There were huge FII withdrawals from the country as well, so that investments could be made in the US.
In spite of all the negativity, it’s not that bad a thing to happen to the Indian market. The good news emerging from the US is that the US economy, which was struggling since its financial crisis, is now showing signs of recovery. The unemployment rate has come down to 7.6% from 9.1% in the last 2 years, and the GDP growth rate is now at 2.4%. Also, the new chairman of the Federal Reserve, Janet Yellen, said that the bank will cut its bond-buying program down to $15 billion a month, and also indicated that this phase of quantitative easing will end in October. The Modi government is also working actively to increase Indias investment portfolio, by having various bilateral talks with many developed economies. This is likely to have a successful trickling-down effect on many emerging market economies, including India, and should work fruitfully under the leadership of the RBI governor, Raghuram Ranjan.
Sources:
- http://en.wikipedia.org/wiki/Quantitative_easing
- http://stockshastra.moneyworks4me.com/economic-outlook/quantitative-easing-meaning-and-impact-on-indian-economy/
Arpit Goel is currently a first year student pursuing Bachelor of commerce( Hons) degree in Sri Ram College of Commerce, University of Delhi. He believes in expression of writing and loves sharing his experience with others.Being a Delhite he loves exploring places and trying different cuisines of food. He is aspiring to be an IAS officer in the future.In his free time he loves reading books, listening songs ( any genre) and watching movies(lots of movies!!!). His interests lie in the area of Indian economy, International relations,financial markets and Philosophy. He can be reached at: arpitgoel.srcc@gmail.com
Edited by Anjini Chandra, Senior Editor, The Indian Economist