Impact of QE3 on Indian Equity markets

Let's Pray my monetary works this time.... 3rd time lucky!!

The world has spent most part of the last 2-3 years gripped in fear of a meltdown in the Euro-zone and its eventual breakup and a sustained slowdown in economic growth in the US. This has had its impact on equities market and other risky asset classes over the past couple of years. But the world leaders have been making all efforts to ensure no such financial catastrophic events occur. Quantitative Easing (QE) and bond purchase has been their most powerful weapon in this effort. The most recent round of QE which has been coined as QE3 and the simultaneous Bond purchase announced by ECB last month, would have its impact on the risky asset classes in the near to medium term for sure. Below i have put down my thoughts in the form of a Q&A session to make it sound interesting. 

What would you advise investors and advisors in light of the recent QE3 and ECB action?

With the ECB determined to do whatever it takes to preserve the euro and the Fed promising to buy securities in the open market until the US economic recovery accelerates, a substantial amount of downside risk to markets has effectively been removed. Given this unusual degree of support from the major central banks, we recommend advisors and investors to take a more constructive position toward risk and equities.

With the global growth environment expected to stabilize in the next few months, sizeable forthcoming liquidity injections by central banks are likely to lift risky asset prices to new highs, and investors should take advantage of that by moving out along the risk curve. This move is not being driven by valuations, but rather by extraordinary monetary policy support. For the rally to sustain in the longer term, an improvement in global economic growth would be required in the next few quarters, and hence we would recommend investors to also time their exit from the risky assets at the right time when valuations look stretched and not get caught on the wrong foot incase global growth falters in the next several quarters. However, that is not the story for this year as a new cycle of monetary support is just beginning, cyclical sectors continue to operate at low levels, and valuations are not overly stretched in a number of risky asset classes.

How would QE3 impact the economies of emerging markets and India?

Though QE3 and its liquidity flows into emerging equity markets would be welcomed by all but it would have an inflationary impact on the asset prices in these countries. Inflation has already been giving sleepless nights to the central bank of India and other emerging economies. Rising commodity and property prices would lead to a bubble sort of situation in the longer term. Inflation in food prices would hurt the larger part of the Indian economy stakeholders. However this liquidity flows would also lead to appreciation in the currencies of the emerging economies which would benefit the import bill of these countries. We believe the investors should capitalize on the near to medium term buoyancy in the markets till the liquidity pumping continues.

What is the outlook for Indian markets keeping in mind the other factors that our economy is faced with?

The deterioration in the fiscal position of India has left the government with little space to mitigate the ongoing economic downturn. IIP and GDP data have been on a downhill trip since 2010 and is yet to pickup. Furthermore, the government has been weighed down by a political environment that has curtailed efforts towards reform. The central bank has also made it clear that, with elevated inflation, it remains reluctant to reduce policy rates.

However, there are signs that things are starting to open up on the policy front. The recent actions to increase diesel price, reduce withholding tax on foreign borrowing, and to allow FDI in retail, aviation and other sectors have been important steps forward and could potentially mark an end to the policy stalemate. However, this has precipitated a political backlash including the withdrawal of support for the government by the Trinamool Congress. Reform initiatives are thus at an important juncture. Although there are risks of some backtracking in the face of political opposition, if the government can withstand the political upheaval unscathed we could see a relatively better dynamic evolving in the coming months where policy crisis diminishes, some progress is made on fiscal adjustment, growth picks up, and the currency recovers ground.

After seeing the steady flows into Indian equities, how do you see the trend ahead?

Flows into emerging market equity funds soared to $4.3 billion in the week ended Sept 19, from a meager $447 million the previous week, according to fund tracker EPFR Global. That drove these funds' assets under management up 0.6%, marking the second largest weekly inflows for the year. Indian equities have seen FII inflows in 2012 of around $15.9 billion till the end of Sep’12. This is one of the highest inflows ever seen and I believe we would close the year better than that seen in calendar year 2007 when we had $17.5 billion of FII inflows in Indian equities.  Previous rounds of QE1 and QE2 are associated with a weaker dollar and gains for higher-yielding assets, such as global equities and emerging market bonds and currencies. Similar expectations will now drive more capital into emerging market assets in the near to medium term.