QE for India?

Is there need for QE/LTRO support for Indian Economy? May be, yes....

The market has been fed with three important factors: (a) severe compression in growth momentum in the Indian economy; (b) very high demand at ECB’s LTRO counter and (c) improved economic data from the US delaying the expectation of QE3 from the FED.

The Euro zone continues to stay vulnerable. ECB has released over Euro 1 Trillion in the form of LTRO financial support. The first support was given in the second half of December 2011 (ahead of year end closure of books) with drawdown of Euro 489 million by 523 financial institutions. This time, the drawdown was higher at Euro 529 billion by 800 institutions. The simple take away is that, the Balance sheets of financial institutions are in severe stress and ECB has chosen to provide temporary relief at the cost of exchequer by funding the Governments with good arbitrage to the investors. While this provides temporary relief to the markets; but could do little to revive the economic growth in the Euro zone in the short/medium term. Rightly so, market got into sell-off mode post the aggressive drawdown from ECB’s LTRO counter against the market expectation of Euro 400-500 billion.

The US zone is showing signs of improvement; economic data so far has been good to arrest unemployment and maintain growth momentum at elevated levels relative to other western markets. This will delay the expected roll-out of QE3 by the FED which was in the radar. The near term expectation is of squeeze in the interest spread between the US and Euro zone; triggering the preference of US assets over the Euro zone, thus shifting the currency strength from Euro to the US Dollar into the near/short term.

On the domestic front, Q3 GDP number was a shocker at 6.1% down on sequential basis from 6.9% for Q2. The FY12 target of 6.9% looks a tall order. The worry has clearly shifted from inflation to growth. The current monetary position of tight liquidity and high interest rates are definitely not growth supportive. There is need for quick shift into aggressive pro-growth monetary stance to achieve a reasonably good GDP number for FY13 around 7%.

If we put all these together, there will be availability of off-shore capital and liquidity into Indian economy. There is very limited downside risk for exchange rate in FY13. Given the bearish medium term outlook on the western economies, there is minimal risk of extended rally in commodity assets. Therefore, strong headwinds on growth momentum from external sector since July 2011 may not be relevant at this stage. As external liquidity chases Indian debt markets, the current money market rates and bond yields are too high and lucrative for foreign investors; thus any downward trend in rate/yield curve may not be negative. Let us not be too generous to offer very attractive returns to foreign investors.

If we assume that fear from weak rupee and high commodity prices stay diluted, it is high time for RBI to shift its attention from inflation to growth. There is need to shift the system liquidity from 1% shortfall to 1% surplus; would need Rs.2 Trillion for this (approx 3% of NDTL). RBI can delay the rate cut process if they can drive the operative policy rate from current 8.5% to 7.5% with this liquidity injection into the system. If things don’t go as expected, it is easy to shift stance through liquidity management rather than rate actions.

As we move into midterm monetary policy review (on 15^th March) followed by Union Budget (on 16^th March), it is not bad idea to look at QE options (taking cues from what FED and ECB has done) to release the severe liquidity pressure in quick time (rather than a long-drawn process of CRR cuts every 45 days or through unlimited OMO purchases) to arrest further slippage in growth momentum. It would send bullish signals across all asset classes to provide “feel good” mood ahead of Union Budget.

Moses Harding

Executive Vice President

Head – ALCO and Economic & Market Research

IndusInd Bank, Mumbai