On an ECB high

Europe's stimulus may overheat Indian equities

The decision of the European Central Bank, or ECB, to implement a new quantitative-easing programme on a large scale will ensure floods of new liquidity flowing into global financial markets. Prices responded instantly to the ECB announcement with stock markets shooting up everywhere, while the euro was bid down to 11-year lows against other currencies. The ECB's quantitative easing, or QE, is complicated. It is weighted across the region with 19 different national central banks involved in implementation. An extra euro 60 billion per month is to be pumped out until September 2016, at least. Some of that money should move into risky assets, such as emerging-market equities. The Nifty and the Sensex have both shot to new highs on that hope.

The ECB's action was expected. It was the magnitude that surprised analysts, who were expecting a smaller QE to the order of about euro 50 billion per month. Meanwhile, the Bank of Japan, or BoJ, continues its own QE, which is open-ended in terms of time and massive in scale. Between the ECB and the BoJ, there will be roughly $140 billion of new QE funding being put into circulation every month. The United States Federal Reserve concluded its last QE in September 2014, but it continues to hold interest rates effectively at zero even though the American economy is growing quickly. Other central banks have also taken actions to induce monetary easing. India, China, Denmark and Canada have all cut rates recently. The Swiss have introduced negative nominal rates and also untied the franc from its erstwhile peg to the euro. As a result, there is enormous turmoil across

currency markets.

This sort of widespread central-bank action was last seen in the immediate aftermath of the sub-prime crisis. The Japanese and the Europeans are using QE to combat deflationary trends. China is easing to stimulate its slowing economy. The Fed is not raising rates for fear that it would cause a sudden hardening of the dollar and over-investment into United States treasuries. But purely monetary solutions cannot be enough to revive growth rates. This is also true for Japan and Europe. Both currency zones need more than just a monetary fix to help deal with the current stagnation.

The excessive liquidity has already resulted in asset inflation. Europe and Japan's stockmarkets are trading at seven-year highs, while India's indices are at record levels. This is unusual, given that Japan and Europe are on the verge of recession, while Indian growth is also below par. In the last 12 months, India's Nifty has climbed 39 per cent. The index price-earnings, or PE, ratio has moved from 18.5 to 22.5. Earnings per share has grown by just 14.5 per cent in that period. These valuations seem inflated. If this bull run continues and accelerates on the back of the new ECB stimulus, stock market valuations could soon be seen as unsustainable.