Fed Tapering – What it is and what can be impact?

Stock markets goes into a swing as and when there is news on ‘tapering’ by US. If there is news on push back, the markets react positively but the moment there is a news on ‘tapering’ being implemented, the market goes onto a tailspin. Lets first understand what actually is ‘tapering’ that is generating so much instability in markets world over.

We know that short-term interest rates are reduced whenever a need is there to stimulate growth. But in the process, Fed reduced the rate effectively to zero which means that there was no scope further to stimulate growth. US Fed used Quantitative Easing to fuel growth that meant it started buying long-term financial assets or bonds from commercial banks and private institutions that was aimed at reducing the yield on bonds that would have led to lowering of borrowing costs ultimately fueling growth. There has been so far three round of QEs popularly known as QE1, QE2 and QE3 through 2008 to 2013. Recently there was news that the US would gradually reduce funding to this bond purchase program that is commonly known as tapering.

From 2008 to 2010, Fed pumped in more than $2 trillions in the financial markets and kept in pumping more money as we can see. However, it did not translated into growth in US markets as was expected. The growth normally is realized if the money available with banks through this program is lend to local borrowers. Then where did this money go? On one hand, when the growth was stagnated in US and European markets, Asian economies like China, Singapore, India were not effected by this global downturn. Even though business were experiencing slow growth, property market and stock market was booming. To think of it, ideally ‘tapering’ should not have any effect on global market as Fed stimulus was aimed at reviving US economy and as it seems reviving, Fed is withdrawing the stimulus. It should be a local phenomenon .

So it can be safely assumed that Fed stimulus has actually made way to these emerging economies. Financial and private Institutions of US have been investing the Asian countries particularly India  and China. Between 2009-2012, property prices in India have more than doubled, inflation has assumed alarming proportions with no sight of it slowing down, and most of the stocks returning more than 20% despite no growth signs. Though exchange rate fell from over 50 in 2009 to 45 in 2010, it was almost stagnant at 45 rupees a dollar till mid 2012. My guess is that to keep the exchange rate competitive, Central Bank pumped more rupees into the Indian economy. Ideally this should have translated into investments for future growth of the economy, but that was not the case.

Is QE leading to this?

So where did all this extra money go? Most of the money made its way into the property market. That probably was reason for such high appreciation in property markets.  I know many a friends of mine who have shifted their focus from their industries to real estate. Also as more and more money was available into the hands of public, this was also one reason for high inflation during this period. In last five years, average inflation rate was also high at around 9% over last 5 years, and  unfortunately for us, it did not translated into growth of Indian economy.

With tapering, financial institutions in US would need the money for paying for bonds on maturity and they would be taking back the money pumped into emerging economies like India. With no buyers and large number of sellers, this could actually led to collapse of stock markets and property bubble burst in India (and other economies). Though Us government has been giving mixed signals on tapering, there is a huge risk of this happening. RBI governor is aware of this and probably the reason for tightening of monetary policy since he took charge. But the risk still looms and we all should be prepared for this plunge.

But I also have a view is that though tapering is going to impact us in short-term, it will be beneficial in long-term as the recent inflation was not growth-led. This might actually turn out to be blessing in disguise and may led to revival of Indian economy. It might also bring back local investors to stock market who have been shying away because of prevailing uncertainty. Property market might bring in actual buyers rather that speculative investors. It is a hope for now that can turn into an opportunity by effective fiscal and monetary policy and efforts from the government. Hoping for it to happen!

The views expressed in this blog are my personal views

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