For the first time in the history, a US Federal Reserve chairman visited India and met with RBI. Financial markets around the world watch every move that Ben Bernanke makes. Trillions of dollars move from one market to another if US Federal Reserve cuts or raises interest rates.
The idea of making this trip was to explain the US monetary policy of quantitative easing or 'QE' to India.
Here are few pointers that could help you comprehend why this matters to India's stock markets and businesses:
Quantitative easing means buying of assets by a nation's central bank in order to inject money into the financial system. The US Federal Reserve has used this method to provide easy money to banks so that they can lend to businesses at cheap interest rates for expansion and thus stimulate growth. The move is expected to create more jobs in America. The priority for US central bank is to stimulate growth in their country. The intention of quantitative easing is not to affect the world. However, since financial markets are inter-connected, any step by US Federal Reserve to put easy money in markets influences the world including Indian markets.
Quantitative easing cuts borrowing rate. The idea is to discourage savings by individuals and businesses. The US economic growth is dependent on spending by individuals and businesses for consumption of goods and services. With interest rates staying at near zero per cent, individuals and businesses are forced to invest in risky assets like stocks, bonds or debt instruments or commodities to earn a return on savings. This floods money into global investment institutions.
Global financial institutions drive money that flows into various markets around the world. A loose monetary policy means global banks are flooded with cash that they have to deploy in productive assets. This results in more money flowing assets like debt, equity, commodity among others. There is a concern that the easy money from US could inflate commodity prices. However, since the launch of the third quantitative easing by the US Federal Reserve, commodities like oil and metals have remained flat.
Easy money overseas means that Indian companies could resort to borrowing more overseas. According to the latest RBI monthly data for August 2012, Indian companies sought permission to borrow to the tune of $ 2.4bn. Borrowing overseas is good if interest rates are low but with the Indian rupee remaining volatile, companies could get hurt due to currency losses. If the rupee remains stable, the overall borrowing cost of companies could fall. However, if it falls further, companies may have to pay more.
Foreign institutional investors have injected close to $ 18bn in Indian equity markets. The BSE Sensex has gained over 15 per cent in 2012 thanks to this money from FIIs. This is despite India's government taking steps to annoy foreign investors by introducing general anti-avoidance rules in the budget. Market experts say that this is because FIIs have limited investment option for investment in the world and India is among few economies that has witnessed any growth. Experts say that many bought Indian equities in anticipation of the quantitative easing announced in September by US. The quantitative easing will ensure that FIIs would not pull out money so quickly from India.
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