Since the beginning of 2020, policy makers have been busy fabricating measures to contain the spread of covid-19. This has led to decline in economic activities and rise in unemployment. Besides, unexpected oil price shocks have added to worries of decision makers.

In restricting the pandemic and the related economic downturn, many developed economies faced short-term interest rates nearing zero, or even slipping to negative. Several central banks around the world engaged in unconventional monetary policy interventions in the form of long-term asset purchase programs, commonly referred to as quantitative easing (QE).

Since March, eight central banks of the developed economies made QE announcements. Notably, US initially announced a $700 billion purchase on 16 March, followed by an announcement of ‘unlimited’ purchase on 23 March. UK announced a purchase on $200 billion on 19 March.

Covid-19 QE Announcements by Developed Countries

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Source: Central bank of the respective eight developed countries

Spillover of QE – India’s concerns

While the central banks of developed economies aim to mitigate the dysfunctionalities in their targeted markets, the QE interventions will have spillover effects linked with higher volatility in capital flows, currency and financial markets in developing economies, including India. An impulse study of QE-triggered US and UK interest rate shock on Indian 10-year sovereign bonds suggests that the spillover effect is immediate and the associated implied volatility subsides in 10 days. The impact primarily depends on the cyclical position of the Indian economy and the stability of its financial system, in other words the scale of its market imperfections.

The lower bond yields, resulting from QE of developed economies can boost India’s growth opportunities, provided we are operating below capacities. In contrast, they can overheat the economy if we are working above capacity, which we are certainly not. Nevertheless, the spillover of QE interventions in developed economies can potentially destabilise the currency and the financial markets. This is primarily because of the incapacity of the growing economies to absorb the capital and the potential speculations in the markets, leading to excessive credit growth and pricing bubbles. Such market volatility fuels financial turmoil. However, with increased Indian financial market depth and regulations in the recent time, we expect to contain such speculative bubbles in the near future.

Indian bond yield vs US bond yield

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Indian bond yield vs US bond yield
Indian bond yield vs UK bond yield

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Indian bond yield vs UK bond yield

It is essential that we weigh the impacts of exit of QE programmes by the developed economies in preparing ourselves for adequate domestic interventions in the coming months. While arguments in favour or co-ordinated QE interventions have been raised previously, in the current unprecedented pandemic era coordinated movements are least expected. Starting from October 2020, we can anticipate a potential exit of QE programs by the developed economies.

This can lead to an outflow of capital and volatility-spikes in the financial markets. We are most likely to witness depreciation in currency and fall of equity prices due to portfolio rebalancing. Government yields are also expected to go up.

The degree of the impact of a QE exit on the Indian economy and its financial stability will depend on several factors: i) the scale of India’s exposure to the developed economies, through financial linkage and trade, ii|) India’s cyclical economic position, i.e. if we are slowing down, then reversal of capital flows will widen the output gap, iii) size of current account deficits, i.e. higher debt levels will make an economy more vulnerable, iv) the depth of Indian financial markets – greater the depth, greater will be its sensitivity to movements of assets in the developed economies, v) the policy interventions that will be aimed to mitigate the effects of capital outflows and vi) the economic impact of the policies taken to prevent the spread of the covid-19, such as the lockdown measures.

Overall, economic data have been very consistent with the global slump in all major economic activities around the world. This further corroborates that the unconventional monetary interventions will have spillover effect through various channels, such as global trade, global liquidity and global portfolio rebalancing. However, what remains to be seen is the ‘impact of the novel coronavirus and its propagation.

In other words, the present global recession is not triggered by financial misconduct or alike, rather this is a recession that is a result of concerns in health security and a collapse of healthcare system across many countries. This recession in many terms is comparable to The Great Depression of 1929 and beyond. Yet, we believe that India is in a much stronger position as compared to the rest of global economies when it comes to financial independence, inclusive economic stability and sustainable growth prospects.

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