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Fed tapering in American Economy

Text of Fed Tapering

  • 30/3/2014 Mrunal [Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on Indian Economy, Worst case scenarios, Balance of Payment Crisi

    http://mrunal.org/2014/03/fed-taperingpart1-2-meaning-fed-tapering-negative-impact-indian-economy-worst-case-scenarios-balance-payment-crisis-expla 1/11

    [Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on IndianEconomy, Worst case scenarios, Balance of Payment Crisis, explained

    1. Prologue2. What is Fed tapering3. Why is it called Fed Tapering?4. How can Fed Tapering affect India?5. Worst case scenario [WCS] by Fed Tapering

    1. WCS1: Hot money gone / Flight of Capital2. WCS2: Weaker Rupee= bigger CAD + bigger inflation3. WCS3: Exports may not increase

    1. Dushmani 4DEVYANI= less EXPORTs2. Special 301 report & Priority status= less EXPORTs

    6. BoP crisis: How can that happen?7. Can Fed Tapering really cause BoP crisis?

    Prologue

    1. you already know about Quantitative easing and its impact on Indian economy. Click me.So far we know that:

    2. in this article, well learn the basics of Fed tapering and its (possible) negative impactson Indian Economy.

    3. in the next article= Steps taken by RBI +Government to immunize Indian economyagainst the negative impacts of Fed Tapering (currency swap agreements etc.) click me

    What is Fed tapering

  • 30/3/2014 Mrunal [Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on Indian Economy, Worst case scenarios, Balance of Payment Crisi

    http://mrunal.org/2014/03/fed-taperingpart1-2-meaning-fed-tapering-negative-impact-indian-economy-worst-case-scenarios-balance-payment-crisis-expla 2/11

    In the first article, we saw that:

    Subprime crisis:

    Investors money stuck in mortgage backed securities and other toxic assets.You may visualize this as a Draught of dollars.

    Quantitative Easing

    American RBI (US Feds) launched a program to buy toxic assets and governmentsecurities from market.Result? Dollar supply increased. (Because central bank is buying stuff from someoneand paying them in dollars.)You may visualize this as American RBI opened all gates of the dam to send maximumquantity of water (dollars) to American farmers. Although lot of that water- went toChinese and Indian farmers as well!QE was carried out in three phases. Finally in Dec 2012, Chairman Ben Bernankeannounced that hell stop this water-supply when EITHER unemployment rate is 2.5%. Because each condition implies that American farmers arebooming, hence no need to give them lot of irrigation water (dollars) under Rajiv GandhiSinchaai yojana Quantitative Easing.Dec 2013: Finally Chairman Ben Bernanke sees American farms are booming, there isno need to release lot of water from dam (dollar supply). [in reality unemploymentrate became lower than 6.5%]

  • 30/3/2014 Mrunal [Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on Indian Economy, Worst case scenarios, Balance of Payment Crisi

    http://mrunal.org/2014/03/fed-taperingpart1-2-meaning-fed-tapering-negative-impact-indian-economy-worst-case-scenarios-balance-payment-crisis-expla 3/11

    So, he starts closing dam-gates one after another. Result? water supply (dollar) reduced.This is fed tapering. Observe

    Time Bond Buying Program (Billion USD)

    Dec 2013 85

    Jan 2014 75

    Feb 2014 65

    March 2014 55

    At this rate, canal doors should completely shut down @October 2014. (Because now the newChairman Jenet Yellen is reducing the water supply (dollars) by 10 billion USD per month.)

    Why is it called Fed Tapering?

    In above graph, observe that the Width of canal / graph is decreasing constantly. (inother words, Dollar supply is decreasing).Tapering is a mechanical term, to describe such constant decrease in width.And since this is being done by US Federal Reserve, so we call it Fed Tapering.Formal definition: Fed tapering is the gradual reduction in the bond buying programof the US Federal Reserves.

    How can Fed Tapering affect India?

    From Mexican drugloards to Hongkong smugglers to Russian arms dealers to ItalianMafias to Indian Bookies n Match fixers- everyone uses dollars. So any increase ORdecrease in dollar supply affects all economies.In last article, we saw the effect of Quantitative Easing (=increased dollar supply) onIndian Economy.

    Let me summarize that in a table:

    Indian point ofview

    DollarSupply

    FDI-FII ExchangeRate Export

    Rs. becomesStrong Down due to Subprime +

  • 30/3/2014 Mrunal [Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on Indian Economy, Worst case scenarios, Balance of Payment Crisi

    http://mrunal.org/2014/03/fed-taperingpart1-2-meaning-fed-tapering-negative-impact-indian-economy-worst-case-scenarios-balance-payment-crisis-expla 4/11

    Quant. Easing HIGH Increase 09=5010=44

    Greece/Eurozone crisis.

    Since QE = increase dollar supply and Fed tapering= decrease in dollar supply, so by commonsense, every effect should become reverse, right?

    Indianpoint ofview

    DollarSupply

    FDI-FII ExchangeRate Export

    Quant.Easing

    HIGH Increase

    Rs. Becomes Strong

    2009: $1=50rupees.2010: $1=44rupees.

    Down due toSubprime +Greece/Eurozone crisis.

    FedTapering

    Medium Decrease

    Rs. Becomes Weak

    March13: $1=55May 13(rumor ofFed taperingstarts)Sep 13: $1=66Rs.

    Not as high as expected. (moregiven in later paragraphs)

  • 30/3/2014 Mrunal [Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on Indian Economy, Worst case scenarios, Balance of Payment Crisi

    http://mrunal.org/2014/03/fed-taperingpart1-2-meaning-fed-tapering-negative-impact-indian-economy-worst-case-scenarios-balance-payment-crisis-expla 5/11

    Lets not waste more time in ball by ball commentary and jump directly to:

    Worst case scenario [WCS] by Fed Tapering

    Every once in a while, Rajan and Chindu make press statements that Indian economy isstrong enough to survive the negative effects of Fed tapering.Meaning, atleast one expert in the whole world -believes that Indian economy is bogusand well be thoroughly devastated by Fed Tapering. (otherwise Rajan/Chindu did nothave to keep giving such explanations to media.)So lets check the possible worst case scenarios. How can Fed tapering hurt Indianeconomy?

  • 30/3/2014 Mrunal [Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on Indian Economy, Worst case scenarios, Balance of Payment Crisi

    http://mrunal.org/2014/03/fed-taperingpart1-2-meaning-fed-tapering-negative-impact-indian-economy-worst-case-scenarios-balance-payment-crisis-expla 6/11

    WCS1: Hot money gone / Flight of Capital

    FIIs takeout their money from India to reinvest in USA (Because Fed tapering impliesthat US economy is recovering. So, American investors may want to re-invest in USA.)

    Result?

    Sharemarket may go down (may even crash- if there is largescale exit of FIIs)=> desiinvestors money lost.Rupee will weaken further. How?

    Suppose an American FII (say Morgan Stanley) invested in Reliance infra.shares. But now hewants to exit.

    Morgan sells those shares= get gets paid in rupeesBut he wants to re-invest money in USA = he needs dollars. Not rupees. Therefore, hellsell those rupees to get dollars (onion).

    Supply of onion(dollars)

    Decreased because of fed tapering. (recall those dam gates are beingclosed one by one)

    Demand ofonion (dollars)

    Increased because FII is exiting from Indian market.

    Result?Onion (dollar) gets more expensive. $1=65=>$1=70.. In other words,dollar strengthens and rupee weakens.

    WCS2: Weaker Rupee= bigger CAD + bigger inflation

    FII gone = Rupee weakensWhile weak rupee = good news for Exporters. But bad news for importers.Weaker rupee = weve to pay more amount of rupees, to get same amount of crude oil =Current Account deficit (CAD) gets Higher. Rupee weakens further.As crude oil gets more expensive =petrol diesel gets more expensive= transport chargesincrease= milk, veggies everything gets more expensive. (Including raw material.)Raw material gets expensive= input cost of exporters increased = they cannot fully takeadvantage of the new demand created by USA customers/US importers.

    WCS3: Exports may not increase

    Fed tapering = US feds has started decreasing water supply (dollar) from their canal (Bond-buying program). This implies that USA economy is recovering. So, If US economy isrecovering = American juntaa will buy more = Indian exporters will see more demand. (This isthe positive thinking assumption.) but there are two errors in this positive thinking.

    1. Weak rupee = expensive crude oil =Cost of raw material increases. Hence our exportprices may not get that competitive yet, (compared to China, Thailand etc.)

    2. Dushmani 4 DEVYANI (Explained below)

    Dushmani 4DEVYANI= less EXPORTs

    American MNCs love India only as long as we are their call center guys and allow themto open malls and e-commerce sites in India.But as soon as our companies compete in their hometurf @USA, these American MNCswill use every trick in the book to prevent our entry.Indian government mishandled Devyani case- annoyed the Obama administration,creating some bitterness in relations.

  • 30/3/2014 Mrunal [Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on Indian Economy, Worst case scenarios, Balance of Payment Crisi

    http://mrunal.org/2014/03/fed-taperingpart1-2-meaning-fed-tapering-negative-impact-indian-economy-worst-case-scenarios-balance-payment-crisis-expla 7/11

    Now, American business lobbyists are using this negative-sentiment to get Americanregulatory bodies to teach us a lesson and get tit-for-tat. Observe: