QE’s, LTRO’s, Asset Buying Programs etc. RBI needs to just focus on growth

As we all know the US Federal reserve has created a huge amount of USD liquidity with its quantitative easing policies where more than USD 1 trillion was pumped into the system. This has been accompanied by statements propounding the pledge to keep short term rates near zero for an extended period of time. This extended period keeps on getting extended every six months and now stands at till the end of 2014. This was followed by operation twist whose aim is to keep long term interest rates down so that the economy can be revived. Weak housing and employment situation in the USis prompting this move from the FED. With their view that there is sufficient slack in the system and that inflation will not come up anytime soon this policy suits them fine at this stage. However at some stage it will certainly create inflation and how they unwind at that stage will be important to see. However with M3 growth in the USnow picking up the policy seems to be having its desired effect.

The ECB although refusing to print money like the FED has come out with a unique idea of creating quasi cash through their Long Term Refinance Operations ( commonly known as LTRO’s). Here the ECB is taking pools of government bonds, corporate bonds, other pools of bonds etc with haircuts depending on the quality of the collateral and giving money to banks in the Euro zone. One such move a couple of months back saw banks taking in nearly 400 billion Euros for three years at around 1% cost. Another LTRO is planned at the end of the month where it is expected that another 600-700 billion Euros will get taken out and as such increase the ECB’s book by more than 1 trillion Euros. Now this is different from pure money printing as here banks need to keep capital for the collateral they are providing and there are also haircuts so the effective cost might be higher than 1%. The main aim of this program again is to boost lending into the economy in light of significant deleveraging of balance sheets of banks. Also with banks not lending to each other the ECB needs to provide liquidity in order to prevent a freeze in the monetary system. Also by creating a carry trade where banks are borrowing long term money much cheaper than what they can do under the current circumstances it is estimated that this move will boost bank profits by nearly Euro 20 billion per annum which is required by banks to boost their capital. This will have two effects; since capital gets boosted the requirements to deleverage will go down. Secondly deleveraging will be more structured and less disruptive.

The Japanese in the midst of all of this and a decline in GDP of nearly 2.3% in the last quarter of 2011 have suddenly got up and realized that we are getting left out in the entire game. As such the Japanese central bank has also announced an asset purchase program of $ 128 billion on the 14^th of February as a Valentines Day gift to the Japanese economy and punters all around.

In midst of all of this our dear RBI is still bothered about inflation despite the inflation numbers being at 6.55% and below estimates for January 2012. I believe that inflation targets cannot be set in isolation and have to be set in the kind of scenario in which we are operating today. With so much money being printing all around and a large part of the inflation being contributed due to cost pressures of global commodities, there is little RBI can do except kill economic growth in India at a time when there is so much cheap money available globally and it is an ideal time to get money into the economy. On the other hand getting the money in is actually the government’s job and they need to pursue FDI reforms vigorously and also create a situation for project specific investments to come into the country in infrastructure projects. With infrastructure projects in Indiaoffering IRR’s of over 15%, it is a perfect investment destination for foreign investors.

RBI needs to take its threshold level of bearable inflation much higher than the utopian dream level of 4-5%. Given the global commodity inflation even if we are at 6-7% for a couple of years it will not be a bad achievement. We need to expand manufacturing capacities, improve infrastructure and productivity to bring down inflation in the long run. By keeping interest rates prohibitively high all RBI is doing is creating stress on corporate balance sheets and reducing their ability to invest in the future. We need both policy actions from the government in order to boost investments and much lower interest rates to get back to high rates of growth. In any case 2.2% of the 6.55% inflation for January was out of Fuel inflation which is not controllable by RBI in any case.

Till a couple of years back policy makers well very concerned about the expected deluge of liquidity that might come into India and whether it will create a scenario of overheating in the economy & also its impact on the exchange rates. Things have totally been reverse with capital flows drying out and the current account deficit increasing. As things stand now, it looks like we are now set to get that deluge of money. Given that the economy is growing slowly and there is headroom for investments and growth that should not be an area of worry today. I don’t think that RBI should be very focused on the rupee at this point of time and waste forex in protecting the rupee. The rupee in all probability has started a long appreciation cycle (with corrections in between). RBI’s forex operations unfortunately have the side affect of sucking out rupee liquidity from the system which is already in a huge deficit.

The markets have shaped up as expected and are near the first target of 5600-5700 for the Nifty. Most bears for now seem to be throwing in the towel after the 5300-5400 level (which was considered sacrosanct and will not be breached kinds) having been taken out easily. I think the 5600-5700 range could be toppish for the near term and should be followed by some correction and consolidation. March has important events for Indiawith the election results and the Union Budget both coming in middle of the month. As such there is no harm being cautious prior to the event. However the bottom up approach should still continue as there continues to be huge value in the broader markets. “The Contra Investment theme” that I had written about in December 2011 has played out very well with huge outperformance from the stocks falling into that theme. Mutual Funds and other domestic investors have increased cash through the rally in January and as such cash in the system is not an issue at this stage. Equity flows into Emerging Market funds have also picked up lately.