Governments of many countries including the US, Britain, Japan have injected vast sums of money into their markets by the method known as quantitative easing (QE). The US for example have done it thrice, calling them QE1, QE2 and QE3, the ongoing one is labelled as QE3. This has increased the US government balance sheet to US $ 2 trillion while UK has pumped in 609 bln dollars and the European central bank by more than 500 bln euro.
This increased money supply, boosted asset prices, marked downs on bank holdings and kept banks solvent. Time has come for this to end. The US fed chairman indicated as early as in June 2013 that they could start tapering in asset prices. This announcement had an immediate impact on the share prices around the world and the yield on the government bonds soared. This is somewhat akin to saying to a drug addict in rehabilitation that he will not get his quota of drugs. This action assumes that the patient already showed a fit and a tantrum. This is exactly how the market behaved.
Some observations are useful.
- Bernanke said that he is not closing the tap completely but instead will taper off slowly. It is upto Janet Yellen to make the decision
- In this regard the November payroll figures due on Dec 6, 2013 will throw some light. If the payroll numbers are very strong, the tapering may happen sooner than later
- QE helped reduce corporate borrowing costs. If QE ends it could mean that the interest rates may move up. It is perhaps a signal to the corporate treasurer to act quickly to raise the money he needs before the tapering starts
- QE tapering could mean good news for the equity market. This may indicate to the market that the crisis is over and so the equity values should move up
- One of the possibilities of prolonged and even higher level of QE is an indication that corporates can continue to borrow cheap. This way the debt level will balloon up in their balance sheet
- Fearing risk due to bulging debt, cost of equity will move up significantly
Finally, RBI must keep a complete watch on what transpires in the US and be prepared to act proactively to prevent the equity and the currency from falling sharply in value. Who says “globalizing is not fun” more so when the future of our economy is very much in the hands of foreigners.