Anand Tandon
Every explanation for market behaviour rests on a series of factors. But here’s a factor cited by everyone pretty much all the time these days: quantitative easing (QE). QE — central banks increasing the size of their balance sheet and using the money to buy up assets — has been deployed by the US, European and Japanese central banks to revive their domestic economies.
Whether or not QE is responsible for the mild uptick in advanced economies, that the gush of liquidity can perk up emerging economy stock markets is almost taken for given by many pundits. Others worry that the liquidity can push up inflation.
India’s economy managers seem to take QE — or the amount of foreign participation in equity markets —seriously as well. But pundits and economy managers in India should take a pause. QE isn’t all that it’s built up to be in terms of an explanation for market behaviour. And a buzzing market is the wrong priority for policymakers.
Missing the Mark
So, what has been the Indian experience since QE? Yield-seeking foreign investors should arrive in droves to arbitrage the growth (and returns) that may be achieved in India when their home country offers zero interest rates. But this hasn’t quite happened in our equity markets. Here’s the data: in rupee terms, the Nifty is up a measly 4% per annum for the last three years, while in dollar terms, the returns are a negative 2% compounded. This muchtouted “liquidity” driver does not seem to have excited equity markets.
Liquidity infusion is supposed to increase asset prices, cause inflation and lead to currency appreciation. In India, stock prices are up about 8% per annum since June 2007, real estate prices increased on average 10% per annum, and inflation (CPI) has been in the same ballpark, while currency has depreciated! Real returns from almost all asset classes seem zero or negative. Only gold — as a hedge against currency depreciation — has held firm.
Strengthen Infrastructure
Can we blame inflation on foreign inflows? Over the last few years, M3 — a measure of money supply — has grown about 16% per year. This fell to 14.2% in the first quarter of this fiscal year, and post QE3, is now at 12.6%. So, foreign inflows don’t seem to have raised money supply. The Economic Survey has identified that there are over Rs 7.5 lakh crore worth of projects stuck in India due to policy issues — mining, environment and land acquisition being major problems. Inflation has mostly been caused by policy inaction leading to supply constraints and also by some policy action — increase of administered prices, energy and food in particular.
The Indian economy needs serious investment in infrastructure. Long-term infrastructure projects are best financed by long-term capital at low interest rates. The global environment offered India just such an opportunity. This was India’s best chance to increase productive capacity of the economy and allow growth without inflation. Lack of focus on “enabling” policy prevented investment in core sectors. In a world where increasing inflation is the target of most central banks, home-made inflation seems to be our own doing.
What could happen if liquidity were to tighten and if rich-economy central banks were to reverse the easy money policy? Well, if the above is true — not a whole lot! Interest rates would rise, as would global inflationary expectations. Since most currencies are engaged in competitive devaluation, the relative effect of currency movements would be neutralised. Real interest rates in India may actually rise — leading to higher savings, lower dependence on foreign inflows and better capital allocation.
Money is not a commodity that remains constant. When dealing with QE-induced money flows, the question “where will the money go” is nonsensical. The money can remain on the balance sheets of banks — as happened in the initial stages of QE1 and QE2. It can also be lost when asset prices fall — like when the real estate bubble in the US burst.
Remove Roadblocks
Investment activity should be, and largely is, based on expectations of future returns. If QE3 works, it is possible that developed markets will provide greater opportunities to investors than emerging markets. Acase in point is the new high that the US equity markets have reached —while emerging markets like India remain below their all-time highs. Trying to guess the timing or direction of money flows is a fruitless activity.
Pundits should know this. India’s economic managers, too, would do well to look at measures that would remove constraints in the real economy rather than focusing on financial markets. Financial markets are meant to serve as the barometer of investment outlook — fiddling with the barometer does not change the underlying reality of a poor investment climate. Never mind the easy money.
(The author is the CEO of a financial services company. Views are personal)
Every explanation for market behaviour rests on a series of factors. But here’s a factor cited by everyone pretty much all the time these days: quantitative easing (QE). QE — central banks increasing the size of their balance sheet and using the money to buy up assets — has been deployed by the US, European and Japanese central banks to revive their domestic economies.
Whether or not QE is responsible for the mild uptick in advanced economies, that the gush of liquidity can perk up emerging economy stock markets is almost taken for given by many pundits. Others worry that the liquidity can push up inflation.
India’s economy managers seem to take QE — or the amount of foreign participation in equity markets —seriously as well. But pundits and economy managers in India should take a pause. QE isn’t all that it’s built up to be in terms of an explanation for market behaviour. And a buzzing market is the wrong priority for policymakers.
Missing the Mark
So, what has been the Indian experience since QE? Yield-seeking foreign investors should arrive in droves to arbitrage the growth (and returns) that may be achieved in India when their home country offers zero interest rates. But this hasn’t quite happened in our equity markets. Here’s the data: in rupee terms, the Nifty is up a measly 4% per annum for the last three years, while in dollar terms, the returns are a negative 2% compounded. This muchtouted “liquidity” driver does not seem to have excited equity markets.
Liquidity infusion is supposed to increase asset prices, cause inflation and lead to currency appreciation. In India, stock prices are up about 8% per annum since June 2007, real estate prices increased on average 10% per annum, and inflation (CPI) has been in the same ballpark, while currency has depreciated! Real returns from almost all asset classes seem zero or negative. Only gold — as a hedge against currency depreciation — has held firm.
Strengthen Infrastructure
Can we blame inflation on foreign inflows? Over the last few years, M3 — a measure of money supply — has grown about 16% per year. This fell to 14.2% in the first quarter of this fiscal year, and post QE3, is now at 12.6%. So, foreign inflows don’t seem to have raised money supply. The Economic Survey has identified that there are over Rs 7.5 lakh crore worth of projects stuck in India due to policy issues — mining, environment and land acquisition being major problems. Inflation has mostly been caused by policy inaction leading to supply constraints and also by some policy action — increase of administered prices, energy and food in particular.
The Indian economy needs serious investment in infrastructure. Long-term infrastructure projects are best financed by long-term capital at low interest rates. The global environment offered India just such an opportunity. This was India’s best chance to increase productive capacity of the economy and allow growth without inflation. Lack of focus on “enabling” policy prevented investment in core sectors. In a world where increasing inflation is the target of most central banks, home-made inflation seems to be our own doing.
What could happen if liquidity were to tighten and if rich-economy central banks were to reverse the easy money policy? Well, if the above is true — not a whole lot! Interest rates would rise, as would global inflationary expectations. Since most currencies are engaged in competitive devaluation, the relative effect of currency movements would be neutralised. Real interest rates in India may actually rise — leading to higher savings, lower dependence on foreign inflows and better capital allocation.
Money is not a commodity that remains constant. When dealing with QE-induced money flows, the question “where will the money go” is nonsensical. The money can remain on the balance sheets of banks — as happened in the initial stages of QE1 and QE2. It can also be lost when asset prices fall — like when the real estate bubble in the US burst.
Remove Roadblocks
Investment activity should be, and largely is, based on expectations of future returns. If QE3 works, it is possible that developed markets will provide greater opportunities to investors than emerging markets. Acase in point is the new high that the US equity markets have reached —while emerging markets like India remain below their all-time highs. Trying to guess the timing or direction of money flows is a fruitless activity.
Pundits should know this. India’s economic managers, too, would do well to look at measures that would remove constraints in the real economy rather than focusing on financial markets. Financial markets are meant to serve as the barometer of investment outlook — fiddling with the barometer does not change the underlying reality of a poor investment climate. Never mind the easy money.
(The author is the CEO of a financial services company. Views are personal)
