What would happen when the US starts tapering off its Quantitative Easing (QE) program?

What would happen when the US starts tapering off its Quantitative Easing (QE) program? The flood of money that has entered the emerging markets would start to pull back. And when that happens, prices of all asset classes are expected to fall. We have already seen this happening when the US Fed announced a possibility of a taper. Therefore it is indeed a scary thing to imagine what would happen when the actual tapering off starts. This is something that is worrying nearly all the emerging markets and India is no exception. To all these countries, the International Monetary Fund (IMF) has a simple advice. It is encouraging these countries to give the flexibility to domestic investors to invest abroad . The funds so invested could be repatriated when times take a turn for the worse. This would help support the country's currency and capital markets especially during events that lead to an exodus of foreign capital.

On the face of it, this sounds like a simple and easy to follow advice. But the technicalities are complicated. For India to do so, it would have to open up its capital account. This is something that has been discussed in the past but has not been implemented so far. The problem for India is the pitfall related to freeing the capital account. For although it allows for free inflow of funds, it also allows for a free outflow of funds. And it is the latter that has been more worrisome for India. With the economy in the condition that it is, and the investor confidence sinking on a daily basis, policy makers would be worried about an immediate outflow of funds if they open up the capital account. However, for long term stability, this is a pre-requisite. Therefore policy makers would do well to enact policy reforms and implementation to strengthen the economy from within.