How The See-saw Effects Of US Fed’s Easy Money Policy Impact Indian Market

It has been some time now that the world has recovered from one of the worst economic crises ever. But even now, the fear of another crisis seems to be looming, especially for emerging economies like India and China. Sadly, most of the so-called experts focusing on international economy did not have any early warning of this.

The villains in this case are the policy choices of advanced economies like the US and Europe, and most notably the pullback of Fed’s easy money policy in the US. However, all that took place was not a random or one-off event. Ever since the financial crisis began in 2008 with the bankruptcy of the Lehman Brothers, there have been constant signs that hint towards the domino effect that any damage control policy in the US will have on the developing nations a few years down the line. But to find out how it is going to work, we need a greater understanding of the Fed’s easy money policy.

So what exactly is easy money? As the name suggests, it is a situation in an economy when both banks and individuals can borrow easily due to low interest rates. It is possible when the Federal Reserve allows the cash flow to build up within the banking system. In the US, the Fed did so by going with an $85 billion dollar a month bond-buying programme. This allowed the banks to increase their cash reserves, which trickled down to more lending in the market. In a way, it was a stop-gap solution to pull America out of the mess back in 2008.

But there is no light without darkness. Here’s the flipside of the Fed’s easy-money policy – too much lending raises the fear of inflation within the economy. Even though the value of securities increased during that phase, the fear of inflation could not be controlled. That is why the Fed has to step off the easy money gas pedal eventually. But the US, being the largest economy in the world, also affects the rest of the world and none more than the emerging economies.

The Governor of the Reserve Bank of India (RBI), Raghuram Rajan, is wary of the policies that the US is embracing. According to him, the US’s pullback of such a massive bond-buying programme might negatively impact the Indian market. In a speech he gave in Tokyo, at a gathering organised by the Bank of Japan, Rajan said, “The international rules of the game need to be revisited as the world has changed.” And he is right in saying so, as his fears are not at all unfounded.

When money was ‘cheap’ as a result of the excessive bond-buying spree in the US, the value of assets including property and stocks rose. There’s nothing wrong with that but when the Fed decided to cut back on its bond-buying by $10 billion last August, the value of the Indian rupee plummeted drastically, at times even by 20%. In fact, it dropped to its lowest value of Rs 68.80/US dollar since mid-1940s.

It was a dark period in Indian economy and many believe it is one of the key reasons why Indian voters lost their trust in the then ruling UPA government. The Lok Sabha poll results declared last month proved this to be true and a more investment-friendly Bharatiya Janata Party is now in power. Naturally, this has lured back some of the investors. This year, the S&P BSE Sensex is up nearly 16% and the INR has regained its value to some extent. Currently, it is swinging between 58 and 60/US dollar every day.

But if we look at the bigger picture – the international economy and how different countries’ federal reserves are holding the market up – the situation is a little more on the dark side. Japan and Europe have also followed the U.S. easy money policy to shield and build up their own economies. If the value of the yen and the euro is so dependent on Federal assistance right now, one can only imagine how drastic and disastrous the repercussions will be when the US, Europe and Japan start pulling back their bond-buying practices.

According to Rajan, “Ideally, market players would exit trades gradually and asset prices would fall gently.” In an ideal international economy, there will be an independent agency to control the spill effects of monetary policies of one country towards another. But this is not that ideal world and our current system of economy does not protect emerging countries. This is sad and substantially risky because not only does it hamper the much-needed growth of emerging economies, but also makes investments that run the developed nations’ not-so-safe affair.
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