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

http://mrunal.org/2014/03/economy-quantitative-easing-meaning-phases-impacts-indian-economy-rupee-dollar-exchange-rate-pros-cons-positive-negative-asp 1/23
[Economy] Quantitative Easing: Meaning, phases, Impacts on Indian
Economy, Rupee-Dollar Exchange rate, Pros & Cons, Positive & Negative
aspects explained
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:
3/24/2014 Mrunal [Economy] Quantitative Easing: Meaning, phases, Impacts on Indian Economy, Rupee-Dollar Exchange rate, Pros & Cons, Positive & Negative as
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.
As such a Hollywood actor. But assume he also works at Citigroups
Investment operations i.e.
Tom
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
(Recall hes the Boss of American RBI /Chairman of US Fed).Ok
Bernanke 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.
Leo
Sorry uncle-ji. I dont want to take any risk from any borrower. I already
have lot of toxic assets on my plate. Please, try at some other bank.
NRI Alok
Nath
(leaves the office, but not without giving aashirwaad 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
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 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 financial
jugglers 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
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.
This helped in business
expansion= more jobs,
more production more
GDP growth.
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.
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

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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