Data Point. Not much reason to be queasy over QE

RBI Governor Raghuram Rajan recently expressed concern about the US Quantitative Easing (QE) policy’s negative effects, particularly the volatility caused in emerging markets. “While such policies will have positive effects on the country that is initiating them, they should have positive effects on net (basis) for everyone else also,” he said.

Governor Rajan’s displeasure over volatility is understandable – his job as Governor is to maintain stability and that becomes a lot more difficult if a raft of ‘over-reactive’ foreign capital continues to put a spanner into his well-laid out plans. But has QE been harmful to emerging markets? A look at market data before QE and after it came into effect does not indicate any cause for alarm.

The QE policy injects large amounts of money into the US economy to stimulate consumption and growth. The idea is that as banks lend more money, interest rates will remain low, aiding investment. In early 2009, the Federal Reserve pumped $1.25 trillion into Mortgage Backed Securities (MBS) and $300 billion into long-term treasury notes. And between November 2010 and June 2011, over $600 billion of treasury bills, bonds and notes were bought. In September 2013, the Fed reinitiated the open-ended QE, purchasing $40 billion dollars monthly. This, termed ‘QE Infinity’, is still ongoing, although there is talk of tapering it by October.

American investors have been using this newfound liquidity to earn high returns in emerging markets. The average net monthly foreign inflows into portfolios in these emerging markets have increased in the five years when QE was in vogue, compared to the five-year period before QE. For instance, Mexico’s net inflows went from negative to positive and Philippines saw a tripling of inflows.

The lower corporate lending rates have also aided in the doubling of average net monthly FDI inflows for Brazil and an even greater jump for Indonesia. The attraction in these markets is their high rate of growth. On average, since QE, stock markets in emerging economies have provided investors with 25 percentage points higher returns than the US stock market.

The high returns were thanks to high growth relative to the world average. During the course of QE, growth in EMs was 350 per cent higher than world average. Note that the differential was only 310 per cent higher earlier, increasing their attraction. Thanks to QE, average yearly foreign direct investment flows to India from the US have nearly doubled. FDI inflows per year average $12.32 billion now, compared to $6.32 billion in the five years preceding the stimulus programme. Governor Rajan acknowledges the importance of this welcome influx of funds, explaining that “we have relied on foreign capital for a long time and there is nothing bad in relying on foreign capital or having a small fiscal deficit”.

He is, however, concerned about the volatility created by the sudden outflow and influx of foreign capital. For instance, there was a net outflow of $3.8 billion of FII funds from the start of the fourth quarter of 2010 to the end of the first quarter of 2012. This resulted in the Sensex dipping to 15,455, its lowest level since the 2008 crisis. More turbulent times were witnessed in 2013, when the weak rupee led to the net yearly inflows of FDI from the US shrivelling to $5.5 billion − the lowest since 2005.

Data shows there is indeed considerable volatility in the debt market. Standard deviation of the monthly foreign inflows, a measure of volatility, has increased almost seven-fold from 27.9 to 191.8 since the introduction of QE. This came with a doubling of the amount of inflows.

Average monthly net foreign inflows in the debt market have almost doubled to $10.1 million from $5.8 million.

However, the monthly foreign inflows into equity and the stock market itself have become less volatile, as suggested by the lower standard deviation in both. Neither is there any evidence of volatility causing a mass exodus of FDI funds as shown by the similar average outflows before and after QE.

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