Talking Point. Who gained from Fed’s easing?

Two central banks — the US Federal Reserve and the Bank of Japan — unveiled their monetary policies last week.

While financial markets were happy with the Fed’s decision to increase the Fed funds rate ‘gradually’, there was widespread displeasure at the Bank of Japan not increasing its asset purchases. The yen shot up after the announcement, dollar nose-dived, commodities went higher and equity markets fell.

This violent reaction to central bank policies highlights the significance of liquidity in keeping the fragile global economy together.

Besides inflating asset prices, liquidity pumped in by the central banks has also helped build assets in many countries. The catch — assets were not created in the country that did the quantitative easing, they appear to have been created in other countries, through borrowed money. This has, in turn, led to large debt in countries that have borrowed the money to finance this asset creation.

And the sums infused are not small. As on April 20, 2016, the Fed held mortgage-backed securities worth $1.75 trillion, US treasury securities worth $2.46 trillion and Federal agency debt securities amounting to $27 billion; mostly accumulated due to the quantitative easing program. The European Central Bank is reported to have spent over 1 trillion euros to buy back securities to maintain liquidity and the bill of Bank of Japan is also close to $1 trillion.

Surprisingly, the funds infused by the central banks have not resulted in large-scale asset creation in their backyard. An analysis of gross fixed capital formation (GFCF) data put out by the World Bank provides some clues about which countries have benefited by this money. The GFCF numbers show the amount spent by a country on infrastructure development.

Most countries recorded a significant jump in the amount spent on GFCF in 2008, as the stimulus measures began rolling out. But if we compare the gross fixed capital formation in 2014 with the amount spent in 2007 in individual countries, an interesting pattern emerges.

Many emerging economies such as China (235 per cent), India (45 per cent), Malaysia (102 per cent) and Singapore (77 per cent) recorded a sharp jump in GFCF in this seven-year period. But GFCF in the US dipped from $3.2 trillion in 2007 to $2.6 trillion in 2010. While there was a recovery in subsequent years, the investment spending growth in the US between 2007 and 2014 was only 5 per cent; comparing poorly with some of the emerging market economies.

Other developed markets such as Germany and Japan have also recorded a very shallow growth in investment spending in this period. Some countries such as the UK and France have seen a decline in the amount spent on GFCF.

While it can be argued that the fiscal stimulus and support given by their respective governments after the crisis might have helped these countries put up the facilities, it is apparent that a lot of these infrastructure spends were funded through debt that had its origin in the quantitative easing of the large central banks, especially the US.

This assumption is supported by the large growth in dollar-denominated debt to emerging markets since 2008. Robert N McCauley, Patrick McGuire and Vladyslav Sushko write in the Bank of International Settlement’s quarterly review that since 2008, dollar credit has grown more rapidly outside the US than inside. “Dollar credit also expanded owing to its substitution for local currency credit given favourable dollar interest rates and exchange rate expectations.”

According to the BIS, dollar credit to non-banks outside the US reached $9.8 trillion towards the end of June 2015 with borrowers from emerging market economies accounting for $3.3 trillion.

Towards the end of June 2015, Chinese companies had taken the largest amount of dollar loans of $1.1 trillion. Brazil, Indonesia, Mexico and Russia were other countries that had sizeable debt in dollars above $150 billion. Indian companies had $118 billion loan outstanding in the same period.

It is now easier to connect the dots and see how money pumped in by central banks was used to ramp up capacities in emerging economies; that has led to glut in the supply of many commodities. With the crash in commodity prices (brought on by excess capacities coupled with slowing demand), many of the companies that borrowed money to put up these facilities are experiencing a contraction in earnings and are likely to face difficulties in repaying these loans.

The dollar strength would also have increased the repayment amount. If rates in the US start inching up, the interest rate differential will narrow, making these loans less lucrative.

Indian companies too have been borrowing quite heavily in dollars in recent years. External commercial borrowings currently account for 38.4 per cent of India’s external debt of $482 billion. Of this, dollar-denominated debt forms a significant part. The months ahead could turn sticky for these borrowers.

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