Even as the global economy grapples with the after-effects of the U.S. Federal Reserve’s quantitative easing (QE) programme and its withdrawal, QE is back with a bang again, this time from Europe. Though it was expected, the scale of the European Central Bank’s (ECB) bond-buying programme, declared last week, stunned markets, economists and central banks across the world. As per the terms of the programme, beginning March the ECB will buy as much as 1.1 trillion euros worth of bonds from eurozone governments over 18 months. The programme will last till September 2016 or until there is a “sustained adjustment in the path of inflation”. The planned infusion of cash into the eurozone is double the size of what the markets expected, and the ECB has said it would continue to buy government debt until inflation rose to a targeted level of “near 2 per cent”. It is not surprising, then, that bond prices rallied and the euro fell by 2 per cent versus the dollar to the weakest level seen in over 11 years. ECB president Mario Draghi has pointed to the deflationary trends in the eurozone — exacerbated by falling oil prices — as justification for the QE programme, which is bound to raise the hackles of central banks in emerging economies that were impacted by the U.S. stimulus and its withdrawal.
The ECB now joins the Fed, the Bank of England and the Bank of Japan in the list of central banks of developed economies that resorted to unconventional monetary policies to ward off recession and deflation. While such policies may or may not work for them, they certainly are a cause for serious problems for emerging economies such as India. The effect of the withdrawal of the U.S. stimulus programme on India’s markets, currency and the economy is well-documented. The inflation in stock prices driven by generous capital flows and the subsequent problems when the bubble was pricked are too well known for elaboration. And that is precisely why Reserve Bank of India Governor Raghuram Rajan questioned the extended application of unconventional monetary policies; in a public speech last year, he decried the “competitive monetary easing” by developed economies without regard to how it affects other countries. Already, Switzerland and Denmark have felt the impact of the ECB stimulus; the Swiss National Bank was forced to delink the franc from the euro last week leading to a massive jump in its value overnight, while Denmark had to cut rates to maintain its currency’s peg with the euro. The EU is India’s largest trading partner and any depreciation of the euro will affect exporters even as there is the likelihood of strong capital flows into the Indian markets, driving up asset prices. It is time to brace for volatility, once again.