Quantitative Easing – 25th October 2015

                                              Quantitative Easing – 25^th October 2015        

This has become the topic of the Debate in the last few weeks, in the global financial arena . There were different views expressed on whether US should withdraw the stimulus and when. Whether other countries like EU, Japan and China should adopt quantitative easing or not. There are views that IMF should advise countries to shun the Unconventional Monetary policies.

When we look at the History of the world, at any point in History , only few countries in the world achieve high rates of Economic growth and many countries in the world report low rates of growth. This is a cycle lasting for a few hundred years. In 1700’s India and China were the fastest growing economies. After 300 years , we witness such a phenomenon today.

History clearly shows us that it would be impossible to achieve high growths in all the countries at the same time. Whatever measures adopted to stimulate economic growth can stimulate economy only up to an extent and countries have to wait for the cycle to come again to achieve high rates of growth.

Today, high growth is witnessed only in countries like China, India, Asean, few of the African countries and Middle Eastern countries. In the developed world , except US, all other countries are finding it difficult to grow even at 1% p.a . Japan with stimulus is expected to grow at 1.5%.

The crisis witnessed from 2008, was unique and for the first time, there was a synchronised slow down across the world. Of course, countries like India and China were able to weather the storm. The developed countries used all the conventional Monetary and Economic Policies and since there was no end in sight for the trouble, they had to resort to Unconventional Monetary policies. The governments have played a major role in bringing some stability to the economies. IMF also acted in concert and trying to find a feasible solution to end the troubles. But so far, the efforts taken by all the authorities did not meet the expectations when these policies were introduced. One benefit was that governments were able to borrow money cheap and the addition to their debt was limited to mainly the principle amount and addition to the debt in the form of interest was limited.

The low interest rates on capital did not find use in the local markets where funds were raised but found places where they can earn more interest. That is the fast growing , emerging markets today which are short of domestic capital for growth. Some of these markets also have twin deficits, that is budget deficit and trade deficit which was putting more pressure whenever cross border flows take place . But the low cost capital from Developed countries helped the fast growing economies to keep their pace of growth.

Looking at the history, going forward , the immediate economic growth prospects look good in China, India, US, Asean, Africa and Mena countries. There is temporary set back in Economies depending on commodity exports, Russia, Brazil , South Africa, but they should be back to normal within two to three years.

Europe and several other developed countries including Japan, the immediate prospects for growth at least in the next five years is below 2%. The main reason is many of the product categories, there is a saturation in demand and the demand for replacement rate of durables is coming down and people are using the equipments for more time compared to earlier. There is also a tendency to save money. This is a structural factor and these economies will take more than 10 years to get back to higher levels of growth and it should be stimulated through Job creation, manufacturing revival and liberal immigration policies. Even with all stimulus measures, they will grow at less than 2%.

Last time, when Fed announced in 2013 that they were planning to withdraw stimulus in phases, it created a knee-jerk reaction in the global financial markets. The countries which had twin deficit, saw their currencies depreciating very sharply within a few weeks. Only when Fed communicated to the world that what was their thinking, the markets stabilised. Similar trend was observed, when analysts expected Fed to raise interest rates from Sep 2015. But Fed communicated saying that despite conditions were ripe for US to raise interest rates, in the interest of the global economy and financial markets, the decision was being postponed.

The unconventional monetary policies cannot last for a long time. They have to be withdrawn. But considering the high volatility in the Financial markets , it is advisable that the withdrawal process has to be smooth and orderly. The road map for withdrawal should be clearly laid out. The role of governments in this volatile world is to bring certainty to policies and procedures.

While the governments which withdraw stimulus should clearly spell out the road map including the expected date for stimulus, the countries which will witness the outflow of funds should formulate strategies to attract funds from other sources to subside the effect of stimulus withdrawal.

Every economic expert says that if US raises the interest rate, it will affect the world. There was also monetary easing in Europe, Japan and now in China. Despite all , these, every one gives more importance to the policy action from US.

The markets have become again volatile, this year expecting , US to raise interest rates.

Since US is the global leader and wishes an orderly growth in the Economy which is also good for US, US can play a major role in bringing stability to the financial markets world wide.

Raising interest rates by US is also going to make the borrowing costs higher for the US government.

The Fed could come with a statement that this year, the interest rates will not be raised and they would consider raising interest rates by March 2016. In every quarter, they can increase interest rates by 10 bps till they reach 50 bps. Afterwards depending upon the Economic growth and prospects, next course of action could be drawn up.

This will give room for countries to prepare themselves for March 2016. These could be  firm dates for raising the interest rate and this will bring the required stability in the financial markets.

 

R.Kannan