Mrunal Explained_ Quantitative Easing- Meaning,Mechanism,Implication.pdf

8/10/2019 Mrunal Explained_ Quantitative Easing- Meaning,Mechanism,Implication.pdf

1/24

11/21/2014 Mrunal Explained: Quantitative Easing- Meaning,Mechanism,Implication

http://mrunal.org/2014/03/economy-quantitative-easing-meaning-phases-impacts-indian-economy-rupee-dollar-exchange-rate-pros-cons-positive-negati 1/24

- 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

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 reporate solve problem?

6. Quantitative Easing: Electronic Money OUT OF THIN AIR

1. Concept#1: QE = NOT OMO

2. Concept #2: QE = NOTMonetized 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 Phase29. [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 me3. Securitization & Shadow banks click me

Characters in QE movie
http://-/?-http://-/?-http://-/?-http://-/?-http://-/?-http://mrunal.org/2014/01/banking-shadow-banks-wholesale-banks-securitization-functions-features-nachiket-committees-recommendations.htmlhttp://mrunal.org/2012/03/econ-debt-equity.htmlhttp://mrunal.org/2014/01/banking-monetary-policy-quantitative-qualitative-tools-applications-limitations-msf-laf-repo-omo-crr-slr-revisited-before-upcoming-urjit-article.htmlhttp://-/?-http://-/?-http://-/?-http://-/?-http://-/?-http://-/?-http://-/?-http://-/?-http://-/?-http://-/?-http://-/?-http://-/?-


2/24



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:

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 inCitigroups retail banking operations. i.e. serving American

middleclass and small businessmen.

As such a Hollywood actor. But assume he also works at
https://www.flickr.com/photos/97816112@N02/13313317163/


3/24



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 insubprime crisis? Especailly: mortgage based securities / toxic

assets.

Prime borrower He has the aukaat the repay loan

Sub-prime borrower He doesnt have the aukaatto repay loan.


4/24



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 1lakh 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%


5/24



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? Notimportant 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).

TomCruise, 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 moneyand 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


6/24



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


7/24



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?


8/24



Scene #1: NRI Alok Naths Business woos

Ben

Bernanke

(Recall hes the Boss of American RBI /Chairman of USFed).Ok fellas, Im reducing American federal fund rate to

0.25%. Come on! Take loans from me and distribute

among your clients.


9/24



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

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

Leo Im giving no loans to anyone! Im sick and tired of loandefaults. 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 thannothing.

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 AlokNath (leaves the office, but not without giving aashirwaad toLeonardo DiCaprio).

Scene#2: how to make banks lend money?


10/24


http://mrunal.org/2014/03/economy-quantitative-easing-meaning-phases-impacts-indian-economy-rupee-dollar-exchange-rate-pros-cons-positive-negat 10/24

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

Ben

(observing the data of industrial output, employment, GDP

everything. )Although Ive reduced the interest rates, Why is the

economy not improving, why is there no business expansion?

Why are no new jobs created? Aha.Leonardo DiCaprio is the

culprit. He is not passing on my cheap dollars to loan seekers.

Ben(calls up Leo) Man you Stop this nonsense right now, and give

loans to those needy American folks.

Leo

Not gonna happen. Have lot of toxic assets in my account books.

If I give loan to anyone, and he defaults, my Citi group will

collapse completely.

Ben

But man, those toxic assets are Tom Cruises problem. If I recall

correctly, you-Mr.Leonardo-Retail banker- you gave loan files to

the investment arm of Citibank, so Tom must have paid somemoney 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.


11/24



Quantitative Easing: Electronic Money OUT OFTHIN 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


12/24



investors and recover the money.

This is called quantitative easing

Quantitative Quantity of money increased.

Easingstress / 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 sellsOR 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)

American RBI buying toxic

assets from those banks and

financial institutions like


13/24



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.

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 listedthem only to demonstrate how events unfolded.


14/24



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 havebounced 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 morejobs, 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.


15/24



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.

ResultFII 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 0.0217March 2010 (when QE1

ended)44 0.0227

MeaningDollar

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.


16/24



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

ExporterBad

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


17/24



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.


18/24



Is money supply increased or decreased?

Increased. Because Ben is buying sarkaaribonds 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 thirdphase.

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 thedollars 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 eachmonth. (+40 bn worth MBS)=45+40= total $85 billion

dollars injected in the system every month= dollar supply

increased.


19/24



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 =juntaais

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 Hasrecovered. No more need for QE.

Meaning EITHER inflation >2.5% OR unemployment


20/24



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 topump 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: within2008 to 11, gold

prices soared from

~850$ to ~1900


21/24



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 inAmerica.

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


22/24



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 theyhad 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 theirmoney 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 Quantitativeeasing on Indian economy.

POSITIVE NEGATIVE
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


23/24



During the initial

phase: More dollar

supply=>More FII,

FDI investment

This helped in

business expansion=

more jobs, moreproduction 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], wehad 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.


24/24


Mock questions, after we are done with fed tapering in next article.

Visit Mrunal.org/EconomyFor more on Money, Banking, Finance,

Taxation and Economy.

Article printed from Mrunal: http://mrunal.org

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

Copyright 2014 Mrunal. All rights reserved.
http://mrunal.org/Economy

Date post:	02-Jun-2018
Category:	Documents
Upload:	ankit-verma
View:	223 times
Download:	0 times

Mrunal Explained_ Quantitative Easing- Meaning,Mechanism,Implication.pdf

Documents