Impact of QE tapering on capital flows of Emerging countries i.indiaopines.com/swati-saxena/impact-of-qe-tapering-on-capital-flows-of-emerging-countries/
- Quantitative Easing (QE) is a type of monetary policy used by the central bank of the US to stimulate the economy when standard monetary policy became ineffective. During mid of CY 2013, Ben Bernanke, ex-chairman of Federal Reserve announced that if forecasts for the US economy met expectations in CY2014, the indefinite cycle of QE would come to an end and as declared the tapering was started since mid-2014.
- Before the tapering started, the emerging markets greatly enjoyed the benefits of excess US dollars in circulation as FII’s did not hesitate to invest in emerging economies to get the advantage of higher interest rates, which was near zero per cent in the US.
- A stronger dollar may have a significant impact on the financial system of emerging countries, in the event where the Fed hikes interest rates (a hint was given of hiking rates during the Fed meet held in March, 2015) later this year, the dollars are going to fly out of India and all other emerging nations. This would mean deeper cuts in emerging markets and further strengthening of the dollar.
- Low-interest-rate policies from the Fed have encouraged the companies of emerging economies to borrow dollars as they could do it more cheaply than if they took out loans in their local currencies, like the Indian rupee or Malaysian ringgit. So they did: by September 2014 there were $9.2 trillion of such dollar loans outside the United States; 50% higher since 2009, according to the Bank for International Settlements.
- Borrowing in dollars means much of the time it will work out fine, but when the value of the dollar would rise, suddenly the companies will need more of their local currency to pay back the dollars that have since gained in value. Now that the dollar has strengthened and rates are on the rise, it presents a risk and a challenge to many emerging markets as their debts have become more arduous and more burdensome. The challenge for authorities in emerging countries is to understand to what degree their corporate sector is naked or exposed.
- Companies of emerging nations that are primarily exporters might be O.K. in any case, their revenue is in dollars and so it should keep pace with rising debt service obligations. But for those focused domestically, like real estate developers or electric utilities, a more expensive dollar can make it much more costly to service debts. Money coming in is in a local currency like the Indian rupee or the Malaysian ringgit, and it suddenly takes a lot more of them to pay debts owed in dollars. This pressure is likely to follow bankruptcies, layoffs and cost-cutting for individual companies that borrowed too aggressively.
- End of tapering may lead to rise in interest rates, leading an increase in dollar which will have an effect on tightening the supply of money across the global economy. A Malaysian company doing business with a Chinese company will frequently carry out transactions in dollars, not ringgits or renminbi. Dollars will now be available on more stern terms which depicts that the decisions made by Federal Reserve Bank can have a big effect on transactions even when no American companies are involved.
- The impact on different emerging markets varies according to the scale of the country’s trade and financial exposures to advanced markets, their individual cyclical positions and their internal or external imbalances. Thus, we may say that no emerging nation is going to exempt from the consequences of QE tapering or rate hike, but the magnitude of the impact will vary.