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Understanding Fed QE tapering and co-relation with Indian markets

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Understanding Fed QE tapering and co-relation with India
Indian markets nosedived last week and the currency tumbled on fears that the US Federal Reserve (US Central Bank) would taper QE3 or what is known as its asset purchase programme in the US. Federal Reserve, like the Indian RBI is the US Central Bank.
 

Impact of QE 3 on Indian stock and forex markets

The Fed would meet on Sept 17 and Sept 18 to decide on whether it needs to taper-off its bond buying programme. After these two days it is likely that the Fed Chairman Ben Bernanke would announce a decision on its asset purchase programme (QE3) and whether its is scaling down the $85 billion asset purchases that it is making each month.

Tapering of its asset purchase programme or QE3 in the US as it is popularly known tantamounts to less liquidity in the global financial system, which tends to impact global markets, particularly emerging market stocks and currencies.

By tapering-off QE3 the Fed would pump less money into the US economy, against the current $85 billion it is pumping. A lot of this money that it prints by way of asset purchase programme finds its way into global stock markets, particularly emerging markets like India, which then have an abundance of liquidity. Easy liquidity drives stock prices higher and vice versa.

Indian markets get affected in the sense that QE tapering means less liquidity which might prompt foreign funds to withdraw money, invested in the Indian markets. Obviously, when they withdraw dollars, there is an outflow which pushes the Indian currency lower against the dollar.

In fact, foreign funds flows into Indian stock and debt markets have helped India fund its current account deficit (CAD), which has helped support the rupee. Countries with high current account deficit like India and Indonesia see their currencies plummeting when large scale withdrawal of dollars happens. Read more on why a high current account deficit is bad for India here

 

In simple terms, QE tapering off means less money in the global financial system and less money means falling stock markets.

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