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47Global Central Banks & LiquidityDec-21-2020

Global Central Banks & Liquidity

Blog by – Mr. Keval Lakhani (Chartered Accountant - Research)

The year 2020 has turned out to be a complete roller coaster, not just for humanity but also for the stock markets. While most individuals have been trying to link the ground reality and economy to the stock markets, the financial markets have behaved like an independent creature, a very important hint to this lies in “liquidity”. The word liquidity has kept all of us guessing; let’s take a dive to understand the same.

Global banks play a crucial role in determining the flow of money. In order to do so, they have various tools at their use. Some of these tools are in the form of monetary policy and Quantitative easing. Central banks have learnt from their mistakes in the past especially during the global financial crisis in 2008. This time, when the world was hit by the pandemic, the global central banks were better placed to tackle such a situation. The USA fed took pole position in addressing this situation by way of easing the monetary policy (reducing interest rates) and quantitative easing (buying assets from the open market). The global central banks chose to be aggressive this time and this translated into a massive tsunami of money being created in the system. The RBI also has gone ahead to cut interest rates and currently the interest rates in India are at a multi year low.

What did these measures translate into:?

The USA Federal Reserve has gone ahead to slash interest rates to a near zero & they intend to hold on to this for the next 2-3 years. The USA fed also launched a USD700billion quantitative easing package. In totality the Chinese central bank , i.e the People’s Bank of China  has injected US$57billion in the first of the half the year into open markets and has provided US$101Billion in the form of loans. They intend to hold interest rates at such low levels. The European Central Bank has also launched US$750billion quantitative easing plan. Bank of England cut its interest rate to an all time low 0.1% to provide liquidity cushion in the system. These measures amount to injecting “liquidity “. According to various estimates the USA alone has printed nearly 20-22% of all the US Dollars issued since its birth in the year 2020.

While all these dollars had been injected into the financial system in the west, it led to a flow of capital to the emerging markets like India, Vietnam, and Taiwan etc. This has translated into net flow in excess of INR 55000/- crore for November 2020.

While most of the central banks say that they intend to continue low interest rate regime for “as long as possible” and they will take actions “ whenever necessary “ , history suggests to the contrary. It had been noted in the past that whenever the central banks, have aggressively lowered interest rates in the west followed by Quantitative easing, growth seems to have subdued at the same time inflation becomes a big risk factor .

Also Read: Why is financial planning important for investors?

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