‘Every action has an equal and opposite reaction’, rightly discovered Sir Isaac Newton. One of the gazillion applicability-spots of the law is the origin of economic crises and the corresponding measures that central banks adopt. Talking about Economic Crises… we all ought to be thankful to the Great Recession of 2008! Wondering why? I mean, we are now finally able to differentiate between Investment Bankers and Pigeons on definite terms, right? Yes, the Pigeons are still capable of making deposits on new BMWs!
The Great Recession of 2008 affected the entire world economy, the detriments of which prevailed more frequent in some nations than others. As such, the USA had faced its worst recession in 60 years, which was characterised by a huge liquidity crunch in its markets. The financial crisis that preceded the recession period had it resulting in the threat of total collapse of large financial institutions, bailout of banks by national governments and downturns in stock markets and economic activities, which in turn triggered the Great Depression. As a result, the Federal Reserve adopted a varied monetary policy to bring back up a fallen AD in the US economy.
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The need for Quantitative Easing (QE) appeared with the failure of the conventional monetary measures to create a rise in the AD. QE involved buying specified amounts of financial assets from commercial banks and other private institutions, thus raising the price of the financial assets and lowering their yield, while simultaneously increasing the monetary base and ensuring that inflation doesn’t fall short of target. Hence, the Fed as part of its measures increased the value of its assets in the Balance Sheet from less than $1 trillion in 2007 to more than $4 trillion now.
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The successive rounds of QE enabled the Fed Reserve to achieve its aim of creating new money to use in the economy to boost availability of credit, lower interest rates, and of course, spur consumer spending and business investment.Therefore, according to Ben Bernanke, the US Fed Chief, the economy was almost recovered with a fall in the unemployment rate and a picked up inflation, with the continuation of which the Fed Reserve would eventually cease, in other words ‘taper’ QE by mid 2014. This had a huge negative impact across the globe, especially in the emerging markets.
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Impact on Foreign Investment flow in to India:
With the advent of QE, investors who considered US to be a safe haven, were forced to move out their investment due to the low interest rates. Thus, they found higher interest rates in emerging economies such as India. Tapering of QE now may go both ways with the impact. Brushing aside all negatives of short term nature that may hit India, the out went FinMin, P. Chidambaram believes that the tapering wouldn’t bother India, and added that Indian growth was poised to accelerate. Accordingly, fiscal consolidation has taken place and there’s now more FDI in India and a stable rupee as compared to the times of tapering speculations. Factual tongue, the sum total of equity inflows, reinvested earnings and other capital coming in was $28.8 billion in April-January alone, 2013-14. Moreover, any and all basic threats to incoming of investment would be the higher interest rates that may prevail in the US with the tapering undertaking a full swing, which however would further take time. Looking at the positive side, the aforementioned lapse would be more than sufficient for the stabilization of the INR and an added globally competent workforce with realistic growth targets is expected to attract an adequate amount of capital flow into India.
Further, the advent of NaModification also promises more for Foreign Investment. Looking to boost its “Make in India” initiative, the Narendra Modi led BJP government cleared many long-delayed proposals to boost Foreign Direct Investment. Notables include, 100% in railways infrastructure, 49% in Defense and 100% in medical devices.
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Other Positive Conclusions:
The tapering would mean larger export surplus for Indians with USA, as the dollar would go up in value. Even if all odds are beaten, the QE measures undertaken by central banks such as Bank of England and Bank of Japan would suffice any outflow of capital caused by tapering of QE by Fed Reserve. Hence, we may safely conclude that tapering, even if affects the inflow of Investment, it would be for a very short period of time. The impact would rapidly be matched by an export surplus and a flow of Foreign Investment from other nations undertaking heavy QE measures.
Last BUT Least – Negatives:
However, the coast isn’t thoroughly clear for India. The macroeconomic stabilization initiatives that began in 2013 shall have its share of bringing down the Aggregate Demand. This essentially will have lowered interest rates prevailing in India, which is uber-risky given the high global interest rates. Such a narrowing interest rate differential shall put an ad hoc unsteady rupee under further pressure.
The postives evidently outweigh the possible negatives. Thus, unless and until anything volatile strikes, the withdrawal of Quantitative Easing shall easily be easy on India!
By S. Shahid Abdul Majeed
Views presented in the article are those of the author and not of ED.