What is Quantitative Tightening?
· Fed officials are planning to let a maximum of $60 billion of Treasuries and $35 billion of mortgage-backed securities “run off” each month.
Story so far
- Central banks have pumped trillions of dollars worth of cash into their financial systems over the last decade and a half, under a now well-known policy called quantitative easing, or QE.
- But the Federal Reserve is now preparing to put its engine into reverse and start cutting its $9 trillion balance sheet down to size to tackle with the strongest inflation.
- The central bank is likely to start reducing its bond holdings relatively rapidly over the coming months, with a cap of $95 billion per month, according to minutes from the March Fed meeting.
· Quantitative Tightening is the process of reducing the size of the Federal Reserve’s balance sheet – that is, its assets and liabilities.
· In Quantitative Easing, a central bank buys bonds to drive down longer-term rates as well.
· As it creates money for those purchases, it increases the supply of bank reserves in the financial system, and the hope is that lenders go on to pass that liquidity along as credit to companies and households, spurring growth.
· QT means reducing the supply of reserves.
Process of QT
Impact
Impact on India
· Strong institutional outflow of capital from foreign investors as they abandon riskier assets like Indian stocks and securities for US treasury bonds.
· Rupee will come under considerable pressure as measured against the dollar.
· Costlier for the Indian government to raise funds from the bond markets.
Way Forward
- Standing Repo Facility: Can provide as much as $500 billion of cash overnight to the banking system.
- The Federal Reserve Bank of New York can also mount unscheduled domestic repurchase agreements.
