Author:Ravi Srikant,NMIMS,MBA Capital Markets
After the recent announcement by the US Federal Reserve to buy US
treasuries and mortgage bonds worth $40 billion a month, aka, Quantitative
Easing - 3 (QE3), stock market indices around the world posted heavy gains. In
India, the Sensex and Nifty jumped more than 2% each, with the Diesel price
hike and expectations of FDI in retail and aviation also contributing to the
increase. This is the third such initiative taken by the US Federal Reserve in
the past 4 years to improve liquidity and get the US economy growing again by
lowering interest rates. This money, which the banks by selling Mortgage Backed
Securities (MBS) get at artificially low interest rates,
finds its way into commodities and emerging market equities such as India where
returns are much higher. Let us first analyse the impact of QE1 and QE2 to try
to understand how QE3 may impact the country.
The US Fed bought around $1.45 trillion of
mortgage-backed securities and other agency debt during the 14 months of QE1
and around $600 billion worth of securities during the 8 months of QE2.
QE1 came at an important time for the
Indian markets as the Nifty hadstarted bottoming out around 2500 after which it
began its climb. FII’s withdrew around Rs 54,000 crore from January 2008 to
November 2008. After QE1 was announced there was a visible change in sentiment,
which led to inflows of around Rs1,00,000 crores from December 2008 to March
2010. The Nifty doubled during this period.During QE2, there were inflows of
around Rs 40,000 crores but the Nifty actually fell 6 % after reaching a peak
of 6150, just before QE2 was announced. The markets responded positively to QE1
whereas the response to QE2 was muted. This could be attributed to the negative
effect of higher commodity pricesespecially Oil and lack of reforms by the
Indian government hurting investor sentiment.
The Indian basket of crude bottomed out
around 40$/bblaround the time QE1 started after which it doubled to around 80
$/bbl by April 2010. By the end of QE2 in June 2011, the price had moved up to
around $110/bbl. It can be seen that both QE1 and QE2 had a direct impact on
the price of Oil. A higher price of Oil leads to inflation in the country and
as India imports about 70% of its Oil requirement, it affects the balance of
payments. Coupled with a higher subsidy bill, itaffects the fiscal deficit as
wellThe current account deficit in turn put downward pressure on the Rupee,
which inflated the Oil import bill even further.
The
price of Gold has gained consistently ever since quantitative easing as a
strategy was undertaken by central banks around the world. Gold is considered a
hedge against inflation and also against fiat currencies, which are being
devalued by loose monetary policies of the central banks. It went from just
below $800/ounce to around $1200/ounce by the time QE1 ended. It further went
up to around $1600/ounce by the time QE2 ended. Gold imports account for a
major part of the current account deficit, so a higher price definitely worsens
the current account. Gold imports reached a low of around 450 million tonnes in
2008 and reached around 958 million tonnes in 2010. Strong demand despite
higher prices hasworsened the current account deficit even further.
On the whole it can be said that QE1 and QE2
were positive for the markets, whereas on the macro economic front, the current
account deficit worsened from 1.3% of GDP at the beginning of 2008 to around
2.7% of GDP at the beginning of 2011 which further worsened to 3.7% of GDP at
the beginning of 2012 on the back of higher Oil prices and a weak Rupee.
The Consumer Price Index (CPI) that
measures inflation has consistently been above the 8 % mark from 2008 to 2012.
It was below 6 % at the beginning of 2008 and reached a peak of 16 % in the
beginning of 2010. Inflation has certainly worsened after quantitative easing
began and is well above the RBI’s comfort level.
A high fiscal deficit and inflation have
forced the RBI to keep interest rates high, which is definitely hurting the
growth prospects of India.
QE3 involves a purchase of $40 billion
worth of securities a month, i.e., $360 billion a year. Apart from this the ECB
has an open-ended scheme to buy the bonds of the debtor European nations, which
will act as a sentiment booster. It is difficult to estimate how much of the
money will actually be invested in the Indian markets. But if past trends are
any estimate, commodity prices are likely to increasewhich will further fuelinflation
and due to our weak policies increase the subsidy burden as well as the fiscal
deficit as the higher prices are not passed on to the consumers. It is safe to
say that India is a net looser from the QE policy, which is popular with the
central banks of the West.
Recent efforts taken by the government to
reign in the deficit by raising diesel prices by Rs 5, going ahead with disinvestment
in 4 PSU’s will have less of an impact if Oil prices begin increasing again. If
recent trades are anything to go by, Oil and Gold both skyrocketed after the
decision reaching 117$ and 1770$ respectively.
Also, the need for a third QE signifies that
the earlier 2 QE’s failed to deliver according to the central bank’s
objectives, mainly to get the banks lending again and get the US economy
growing again. Unemployment rate in the US has stayed above 8% for a long time
now.
As of now, there isn’t much of an inflation
problem in the US, but there are worries that if such expansionary monetary
policies continue inflation could rear its ugly head which would then force the
Fed to raise rates before its stated year of 2015.
A rise in interest rates in the US would
certainly be very bad for India, as investors will most likely withdraw money from
India to cover up for losses at home which would not only affect the stock
market but also the rupee.
Bernanke has exported his problems half way across the globe, when
the rest of the world has enough on their plate.
