Recently the Indian press in the financial section has shown great concern about the likelihood of QE3 being scrapped and if so how this action will affect our Indian bond, stock and currency markets. As per the current arrangement the Federal Reserve in the US is purchasing $85 billion dollar worth of bonds as well as mortgage backed securities every month. Because of this, new flood of money is created and this helped the US interest rates to artificially low. This also helped the dollar value to stay low against the emerging market currencies. It also helped the banks to increase their reserves and therefore able to lend more money. This excess money pushed up asset prices in the emerging market countries and so did job opportunities.
Now the US Fed is contemplating cancelling or tapering QE3. It will have far reaching impact on the value of the dollar. It will send the value of the dollar soaring especially against the emerging market currencies. Now let us look at its impact on the Indian economy. Fill total inflows in 2012 amounted to $25 billion and in 2013 it stands at $15 billion. If QE3 tapering takes place, this may slowdown the flow of foreign exchange significantly. With the current account deficit of over 88 billion US$ in FY 2013 a reversal of capital inflows will increase the CAD and will reduce the c flow of foreign exchange significantly. With the current account deficit of over 88 billion US$ in FY 2013 a reversal of capital inflows will increase the CAD and will reduce the value of rupee significantly. The Indian stock market may be damaged severely like in 2008 when it dropped from 22000 to 8000. The capital expenditure cycle will find it’s distorted because of the unsteady and slower inflow of the dollar. Companies which remain unhedged and have external commercial borrowing will face higher costs and possible bankruptcy.
So our government must have a contingency plan. If they don’t, the Indian economy will suddenly face a severe liquidity crisis pushing the interest rates higher and the value of the rupee lower and the overall pessimism will spread across the financial market causing permanent damage to the economy. It is sad that India does not have enough gross domestic savings and the higher inflation rate will only make it more difficult. The politicians are not providing the correct inputs to the people about the state of the economy possibly to avoid panic.
Note: RBI just announced that FCNR (B) balance has hit a balance of $30 billion. Eventhough it is borrowed money it gives some cushion to the value of Indian rupee.