Are we prepared for the QE taper?

Tue, 5 Aug Pre-Open

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The party is over! The days of cheap money may soon end with the Fed on the verge of rolling back the monetary stimulus. While most of the officials have digested this news, the worry part comes now. How would life be post the quantitative easing (QE)?

Quite tough is the immediate answer. For we are heading towards testing times! And to begin with is the expected rise in global interest rates. Yes, the next U.S. monetary policy is likely to see the interest rates rising. And on the back of improving growth prospects in the US, money may find its way back to the US. Hence, the money ought to get dearer now. But what would this mean for India?

Due to the powerful presence of the US dollar in international markets, QE tapering has a direct and immediate impact on the rupee and the domestic scene. In the past, each time U.S. decided to announce QE tapering, the news hit hard as nails to the Indian financial markets. Remember May 2013? The time when U.S. had first hinted to trim the QE program! And we all know what happened next. It sent out tremors in emerging markets. And India was the one that suffered the most. Undoubtedly, the stock markets had tanked too. Engulfed by large fiscal deficit, current account vulnerability and high inflation, Indian financial markets ran into severe panic then. Thanks to the Finance Minister then and the RBI Governor Raghuram Rajan who put together best efforts to curtail current account gap, soften the sticky inflation and commit to fiscal discipline. Therefore, despite the global cues, Indian markets remained fairly immune. But that does not mean that India has no reason to worry. India is yet to see macroeconomic stabilization. Moreover, the interest rate differentials between the global and the domestic markets would put downward pressure on the rupee. This is especially in light of higher probability of the RBI rate cut this fiscal.

Remember the Fed's quantitative easing had led to flush of liquidity in the financial markets of emerging economies that supported the artificial growth there. Even the Indian markets had greatly enjoyed the benefits of excess US dollars in circulation. However, at the peak of global crisis, the growth in these emerging economies appeared to be attractive. Consequently this paved way for irrational exuberance. And in turn gave rise to bubbles distorting the real economy. Very clearly, the asset prices became unnaturally inflated by the cheap money.

Today the world is heading towards the end of easy money era. And high time we need to stand prepared. Also, the world needs to prepare for the higher interest rates as these are expected to pace up much faster than anticipated. And that indeed sounds worrisome.

India needs to be more vigilant about rupee movements and the domestic interest rates. While the regulatory moves on monetary policy will be watched out closely, time will tell how the world deals with the taper.