QE Tapering and its effect on Indian Economy


Scarcity of the US dollar in the global markets may not be bad news for Indian economy.

There are few ways to deal with recent news of gradual withdrawal of Quantitative Easing (QE).

First way is to immediately liquidate all non-dollar financial instruments. Obviously that will affect Indian equity and bond markets adversely. Second way to look same issue is bit balanced. We need to evaluate all scenarios. We should understand the implications of shortage of dollar in an economy. While doing this, attention should be given to special needs to Indian economy. Third way to look same problem is to look for other sources of income, to overcome the scarcity of the dollar.

Let’s talk about future of QE. If one goes by Chairman of Federal Reserve, Ben Bernanke’s testimony before the US Congress and the statement issued by Federal Open Market Committee then, starting from September, $85 billion monthly QE payments will be reduced. Market was expecting the same from year end or first quarter of next year.

Why was QE reduction preponed? This was done despite Bernanke being supporter of QE. It was being assumed that QE would continue till the US economy is back on track and unemployment reduces to a satisfactory level. Or inflation starts increasing. But none of that has happened. Although, unemployment has come down, but at 7.5% it is still high, as per the US standards. Inflation is still at 1% and inflation indexed bonds are still trading at 2%, same as 3 years ago.

Just like Alan Greenspan, Bernanke does not like the policies which are against the interests of Wall Street. Therefore it is very much possible, that rate of reduction of QE will be relatively slow, may be $10 billion or even less.

Now comes next set of questions. First, for how long QE reduction will go on. If amount of reduction is less, then market will rebound after small correction.

Second, which countries will be affected most? Countries like India, which are net importers, will be positively impacted. It will help in reducing trade deficit. If dollar remains strong for long, Current Account Deficit can reduce from 5% to 4%.

70 billion yen being given by Japan every month will also compensate the deficit. Its effect has not been seen in the market. But according to data released by finance ministry, money outflow from Japan should be able to compensate reduction in QE by Federal Reserve.

Moreover Japanese money is being invested in long term projects rather than equity investments. Therefore although equity market may not see that much change, but overall difference will be felt in the economy.

Most probably, Indian financial markets will remain unstable for next few months. But once stabilized, they will depend more on domestic events rather than global events like QE.