Effect of Quantitative Easing on Emerging Markets

The average person believes that Quantitative Easing (QE) is a policy being implemented in developed nations like the United States, Europe, United Kingdom and Japan. They believe that the average person sitting in developing economies where Quantitative Easing (QE) is not being implemented has very little to gain or lose from this policy. However, this is not true. The Quantitative Easing (QE) policy has a huge impact on the economies of emerging markets across the globe. In this article, we will trace the flow of how an issue pertaining to solvency of developed nations is causing boom bust cycles across the globe.

Abnormal Inflows

Quantitative Easing (QE) involves the government creating new money and using it to invest in various securities. The securities that were commonly used by the Fed i.e. the Central Bank of United States were agency securities, asset backed securities and treasury securities. Now, there are a limited amount of these securities. The investments in these securities were earlier driven by private investors. However, after the Quantitative Easing (QE) policy has come into existence, these securities have become the exclusive investment avenues for the government.

The private investors have therefore been looking for newer and more profitable avenues to park their investments. It is a result of this policy that the economies of emerging markets have boomed during this period of Quantitative Easing (QE). Private portfolio investors suddenly found that they have limited avenues to invest in the United States. As a result, they started looking out to other countries. Some countries like Brazil, Russia, India, China and South Africa had relatively strong fundamentals. Therefore, investors started pumping in unheard amounts of money in this market. As a result, the stock markets and the economies of these nations underwent a boom during the Quantitative Easing (QE) period. Even now, the mere news of a Quantitative Easing (QE) tapering sends shockwaves in the markets of these economies.

Interest Rates

The interest rates of an economy are determined based on the demand and supply of money in that economy. If the demand outstrips the supply the interest rates rise and the opposite happens when supply outstrips demand. In case of Quantitative Easing (QE), the economies of these nations suddenly found themselves flooded with money. The corporations as well as private individuals in emerging markets had access to a large amount of cash at their disposal. Therefore, the interest rates in these economies have seen a downward trend and the amount of money being lent out has gone up significantly.

Inflation

Inflation is a natural consequence if a lot of money flows in any economy and the interest rates are set low. However, in case of emerging economies, a lot of the inflation has found its way to asset prices. The inflation related to commodities such as food which form a part of day to day survival has been relatively less. This is because the investors have sent their money to emerging markets with an investment point of view. Their money is therefore invested in stocks, bonds and real estate markets of the emerging economies.

Hence, emerging economies all over the world have seen an unprecedented asset price boom during the Quantitative Easing (QE) period. Many experts believe that this is just a bubble that will burst as soon as Fed introduces the Quantitative Easing (QE) tapering policy. Therefore, according to them, it is only a matter of time before the bubble bursts.

Dollar Depreciation

The Quantitative Easing (QE) policy adopted by the United States has caused the exports in the emerging economy to grow exponentially. This is because more and more dollars are leaving the United States. As such more dollars are being sold in the Forex markets. Therefore the price of the dollar relative to other currencies is rising. As a result, Americans can afford to buy more products on the international market because the dollar has a higher purchasing power.

The Quantitative Easing (QE) policy is therefore creating a scenario wherein the emerging markets can perpetually export and the United States can perpetually import goods without any consequences until the policy is changed! The news of Quantitative Easing (QE) tapering is therefore bad news for emerging markets. This is because Quantitative Easing (QE) tapering may hit their exports, therefore their corporations, stock markets and the entire economy will feel its negative effect.

Central Banks in Action

Countries like India have faced the wrath of the markets when there were expectations that the United States will adopt the policy of Quantitative Easing (QE) tapering. The rupee hit its historic low against the dollar for several consecutive days as there was an unprecedented flight of capital outside the Indian economy.

If the markets were left to their own devices, greed and panic would have overtaken the markets. As such, the rupee would have been hammered down even further by speculators looking to make a quick buck. However, the Reserve Bank of India prevented this from happening.

The Reserve Bank started buying rupees and selling dollars in the market to counteract the excess supply of rupees and the shortage of dollars. The Reserve Bank had to undertake extensive transactions and even book losses to ensure that the rupee is within acceptable limits of the dollar.

Hence, the policy of Quantitative Easing (QE) adversely affects the economies of emerging nations. Sometimes the issue becomes so severe that Central Banks have to come into action to prevent further damages!