Impact of EU QE Programme on India and Evaluation of the Programme

Impact of EU QE Programme on India and Evaluation of the Programme

Q. “The Quantitative Easing Programme announced by Europe will impact the Indian economy in a negative manner and increase volatility.” Examine and assess the QE Programme in light of this statement.

A. Impact of the EU QE Programme on India

1. About the EU QE Programme

QE Programme Introduced by European Central Bank/ECB

• Scale of ECB bond buying programme impacted:
- Markets
- Economists
- Central Banks

2. Terms of the Programme

• ECB will buy 1.1 trillion euros worth of bonds from Eurozone governments
• Duration of purchase will be over a period of 18 months
• Programme to last until September 2016 or till the emergence of “sustained adjustment in the path of inflation;” reaching inflation of targeted level of close to 2%

3. Impact on International Markets

• Planned infusion saw bond prices rallying
• Euro fell by 2% versus the dollar to the lowest level in close to 11 years

4. Justification for QE Programme by EU

• Deflationary trends in Eurozone
• Falling oil prices
• Unconventional monetary policies to ward off recession and deflation

5. Impact on India

I. Negative

a. Stimulus Programmes Likely to Dent Indian Markets

• Past precedents show effect of such programmes
Example: Impact of withdrawal of US stimulus programme on Indian markets, currency and economy

b. Inflation in Stock Prices Followed by Fall

• This economic see-saw results when inflation in stock prices driven by considerable capital flows meets an abrupt end when bubble pricked

c. RBI Governor’s Concerns

• Extension of competitive monetary easing by advanced economies detrimental for emerging economies: Rajan

d. Disastrous Worldwide Impact

• Denmark and Switzerland feel impact of ECB stimulus
• Swiss delink franc from euro leading to massive increase in value
• Denmark cut rates to maintain currency peg
• Impact could be felt on Indian economy soon

e. QE Programme Could Impact Exports

• EU is largest trading partner in India
• Any depreciation of the euro to impact exporters

f. Volatility Par Excellence

• Strong capital flows to drive up asset prices
• Volatility consequently likely to result

g. Indian Money Could Be Lost

• Money might flow into European markets

h. Increase of Local Inflation

• Foreign currency enters into India = more money in local market(both domestic and international)
• Local economy exposed to inflation

i. May Cause Local Currency Devaluation

• QE causes currency of EU to devalue and other countries devalue currencies so exchange rates fall leading to:
- Local currency devaluation
- Global currency war

j. Impair Economic Growth

• Local currency devaluation=Consumers unable to purchase more goods and services

l. QE Solutions Could Become Problems

• World could plunge into deeper economic turmoil
• Global linkages can have detrimental consequences

m. Hot Money Will Pour In

• Indian markets will experience influx of hot money and volatile, short term investments
• Later withdrawal can lead to fall in currency value

n. Deterrent for Investors

• Investors will be sceptical to invest in volatile Indian market
• QE programme will raise volatility beyond an acceptable point

o. Rise and Fall = Lack of Stability

• Indiscriminate asset price rise; higher inflation initially
• Withdrawal of QE will result in fall of rupee, further worsened by burgeoning fiscal deficit and current account vulnerability

p. Lower Competitiveness of Exports

• Will lower Euro rates and fuel inflation
• European exports will be more competitive; create unhealthy competition for Make in India

q. QE Lead to Slowdown in Imports

• Euro depreciation will result from QE slowdown
• Imports will become costlier as a result of this

r. Chaos and Fuel for World Recession

s. Negative Impact on Balance Sheets

II. Positive

a. Higher Rate of Returns for Investing in India

b. Inflow of Foreign Financing

• Foreign funds will rush to India since higher rate of return in emerging countries.
• Firms will rush investment to India because it will bring higher rate of return and create more impact
• This could ensure the business climate in India improves as investment pours in

c. QE May Have Positive Impact

May impact the following positively:
• Cross-border capital flows
• Asset prices
• Economic activity

through several channels:

1. Portfolio Balance Channel

• Purchase of longer duration assets such as government bonds and mortgage backed securities through QE
• Reduce supply of assets for private investors increasing demand for substitute assets
• Portfolio rebalancing lowers risk premiums and boosts asset prices, easing financial conditions

2. Signalling Channel

• Risk neutral component of bond yields may decline if future policy rates kept lower
• Big interest rate differentials->trade and capital inflows in India

3. Trade Flow Channel

• QE will boost demands for Indian exports
• Supports domestic demand in the EU-May offset impact on emerging market exports from exchange rate channel

d. Differences in Macroeconomic and Financial Conditions of Emerging Economies

• India’s rupee and stock market relatively insulated from negative effects
• Indian rupee not so fragile: QE therefore more positive than negative for India

e. Equity Markets Benefit

• Inflow of foreign capital likely to advance interest rates or growth opportunities
• Historical benefits under low interest rate regime
• Higher liquidity=More Money Entering into nation
• India to become top destination for investment in equity markets

e. Beneficial Trade and Confidence Effects

• Stronger economic activity in countries with QE
• Lead to increased capital flow, boosting investor confidence in India

f. Financial and Macroeconomic Policies in Place

• India can guard against capital flow volatility and financing as well as economic instability through:
- Macroeconomic
- Financial policy frameworks

g. Clear and Effective Strategies for Monetary Policy Normalisation

• QE provides emerging economies like India a chance to strengthen recovery and normalise monetary policies.

B. Assessment of EU QE

I. Negatives

• ECB President Unveiled USD 1.3 trillion Asset Purchase Programme to boost European recovery

a. QE News not Well Received

• Stimulus prospect sent Euro to lowest level against dollar in 10 years
• US trading Euro was down 2% at USD 1.1367
• Lost 6% of its value so far this year.
• Fell 1.1% against pound to €1.3187

b. Reforms Backfire

• ECB May bail out reform weary governments like Greece instead of saving the EU

c. Asset Issues

• Fed style EU QE may fuel asset bubbles

d. Low Eurozone Rates

• Record low eurozone rates failed to boost EU; ECB to keep low eurozone rates

e. Fall in Bonds

• Shares rose in response to news of EU QE, but bonds fell, particularly in weak EU nations like Italy, Portugal and Spain

f. Addressing Prolonged Low Inflation

g. Large Majority on QE Programme

h. Eurozone Not Sharing Liabilities Equally

i. QE Programme too Late to Save the Day

- Core as well as headline inflation slide
- Medium and long term inflationary exception have fallen
• This can trigger internalisation of low inflation and falling inflationary trends
• Both factored into prices and wages, causing deflation to become entrenched

j. No Wealth Effect

• There is no wealth effect in that EU households do not spend more if they have more
• Moreover, European businesses rely on bank financing and not direct market finance
• Stocks and corporate debt value may rise because QE pumps money into system, but investment and spending will remain low

K. QE Programme Prioritises Stronger States Instead of Helping Weaker States

II. Positives

a. Fall in Cost of Borrowing

b. Banks to Lend More

c. Eurozone Business Receive Boost

d. EU Consumers to Spend More

e. Ambitious Strategy

f. Support for QE from EU

i. Italian FM: QE is

• “ambitious strategy”,
• “good for Europe”
• “push away risk of deflation”
• “Injection of confidence to markets”

ii. EU markets cheer move

g. Spur structural reforms and further integration of the EU single market


Regarding EU QE Programme

• EU’s QE programme clearly has many hurdles to overcome. Strong reforms can boost the QE programme and produce lasting benefits for the Eurozone.

• The chances of more benefits are only possible if reforms are accompanying the easing programme. In fact, ECB head Mario Draghi has requested for reforms to ensure the success of the QE programme.

• Draghi has said redoubling of reforms is needed for the QE programme to be successful. Reforms need to be in the areas of:

- Cutting down red-tapism
- Spurring labor flexibility
- Increasing competitiveness of markets and products

Regarding Impact on India

• India needs to be alert about the impact of easing and tapering on the economy and guard against harm to its export opportunities, state of inflation and value of local currency. The QE programme cannot be a game changer alone for the Indian markets.

• Lasting stability in markets is needed and protection from volatility through stable macroeconomic and financial policies is critical while absorbing the positive impact of heightened capital inflow.

• Towards the tapering period, India needs to be in a less vulnerable position in terms of its massive fiscal deficit. The apex bank will have to use policy instruments to keep the Indian market and the economy steady in the times to come.
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