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11/21/2014

Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

- Mrunal - http://mrunal.org -

[Economy] Quantitative Easing: Meaning, phases,


Impacts on Indian Economy, Rupee-Dollar Exchange
rate, Pros & Cons, Positive & Negative aspects explained
Posted By On 22/03/2014 @ 12:36 am In Economy | 119 Comments

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Prologue
Characters in QE movie
[Act I] Subprime crisis: toxic assets (2007)
[Act II] Quantitative Easing (2008)
Why cant LOW repo rate solve problem?
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
8. [PHASE] Quantitative Easing Phase 2
9. [PHASE] Quantitative Easing Phase 3
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
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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:

when Quantitative easing started, He was the boss of


Ben
American RBI (Chairman of US Federal reserves.) Right
Bernanke
now Fed Chairman= Jenet Yellen.
As such a Hollywood actor. But assume he works in
Leonardo
Citigroups retail banking operations. i.e. serving American
DiCaprio
middleclass and small businessmen.
As such a Hollywood actor. But assume he also works at
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

Tom
Cruise

Citigroups Investment operations i.e.


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.

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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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%
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

interest rate. Sells them at American market. We call them


mortgaged backed securities (MBS).
Because theyre backedup by those loan-papers. If
Mortgage
anything bad happens, Tom can attach those homes,
backed
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,
the retail
banker
Tom
Leo

Leonardo please get me more loan papers. So, I can


printout more MBS securities! And our citigroup makes
even more profit!
But Im already done giving loans to every prime
borrower.
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.
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
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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 subprim 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?

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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

Scene #1: NRI Alok Naths Business woos


(Recall hes the Boss of American RBI /Chairman of US
Ben
Fed).Ok fellas, Im reducing American federal fund rate to
Bernanke 0.25%. Come on! Take loans from me and distribute
among your clients.
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

Leo
(American
retail
Banker)
NRI Alok
Nath
Leo
NRI Alok
Nath

Im going to borrows truckload of dollars from American


RBI because its available at throwaway prices! Have to
pay just 0.25% interest rate.
I want to open a marriage-bureau. Please give me loan.
Im giving no loans to anyone! Im sick and tired of loan
defaults. I want to take no more risk.
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?
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.

Leo

NRI Alok
Nath

Leo
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 plate.
Please, try at some other bank.
(leaves the office, but not without giving aashirwaad to
Leonardo DiCaprio).

Scene#2: how to make banks lend money?


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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

Location: Ben Bernankes cabin at US federal Reserves (=American RBI)

Ben

Ben
Leo

Ben

Leo

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

(agitated, but has to find solution quick, before system collapses


further)OK Leonardo. How about I buy the toxic assets Citigroup
Ben
and all other financial jugglers institutions. Then, will you give
loans to those needy customers? Please?
Leo Fair enough.

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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

investors and recover the money.


This is called quantitative easing
Quantitative Quantity of money increased.
stress / tension of Banks decreased. because American
Easing
RBI (US feds) took away their toxic assets
For MCQ: please keep following concepts in mind

Concept#1: QE = NOT OMO


OPEN MARKET
OPERATION
QUANTITATIVE EASING (QE)
(OMO)
American RBI sells
OR buys
government
American RBI buys securities, including those
securities (treasury TOXIC assets.
bonds) from the
market.
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
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)

QUANT.EASING (QE)

American RBI buying toxic


assets from those banks and
financial institutions like

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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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 takes securities
from government and creates
more money.
Increases the money supply in
the system.

Lehman brothers.
[They also bought treasury
bonds from market, but main
focus was to remove "toxic
assets" from system].

American RBI takes (toxic)


securities from those bankers,
and creates more money.
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.

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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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


2010 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.
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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
Jan 2009
October 2009
March 2010 (when QE1
ended)
Meaning

1$=__ rupees
50
46

1 Rs.=___ $
0.02
0.0217

44

0.0227

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.
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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:
American
importer
American
exporter
Indian
Exporter
Indian
importer

Implications
Bad because he has to give more dollars to buy same amt
of Indian products. []
Good, because now American products cheaper (for Indian
importers) = more demand of American exports.
Bad
Good.

Enough of Phase 1, lets move to

[PHASE] Quantitative Easing Phase 2


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
I bought off
Toxic assets
(MBS) from
Leo

What did Leonardo do


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
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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.]

Ben starts buying (long term) US Treasury bonds from


November
market. He plans to buy total $600 billion dollars worth
2010
bonds during QE phase 2.
June 2011 The QE2 phase ends.

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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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
Nov 2010
March 2011
June 2011

$1=__ Rs.
44
45
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.)

[PHASE] Quantitative Easing Phase 3


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.

Ben starts buying $45 billion worth Treasury Bills each


December month. (+40 bn worth MBS)=45+40= total $85 billion
2012
dollars injected in the system every month= dollar supply
increased.
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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


If inflation gets higher than 2.5%, Ill stop QE.
Because (moderate) rise in inflation =juntaa is
Inflation 2.5%
buying more (hence the demand side inflation)=
economy has recovered. And since economy has
recovered, QE should be stopped.
If unemployment get lower than 6.5%, Ill stop QE.
Unemployment Because less unemployment = definitely there is
6.5%
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


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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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

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

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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

expansion =more jobs=growth.

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
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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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 planningneither 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

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11/21/2014

Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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.)
Cheaper dollar helped
Indian corporates to
borrow from abroad.
RBIs forex reserves
increased. Because cheap
dollars, RBI could collect
more by selling its rupee
reserves in exchange of
dollars.

They would have invested even more if


there was no policy paralysis / GAAR
controversy.
Indias external debt increased (especially
when later 1$=became close to Rs.65)
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.


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Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

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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