World mkts on liquidity high
This could further trigger inflation and delay the much-awaited rate cuts by RBI
India’s financial markets have been building in expectations of a cut in interest rates ever since the Reserve Bank of India (RBI) announced a reversal in its stance. But, the market’s apple cart may be upset by the wave of liquidity unleashed by central banks, globally. From the start of this year, central banks of developed nations have started buying back bonds and as a result, “Asia is getting whipped up,” explains Frederic Neumann, co-head of Asian economics at HSBC.
To add to this, last week, Bank of Japan surprised the world with its asset purchase plan. It expanded its asset purchase program by $130 billion. Another surprise came from the People’s Bank of China, which announced an unexpected cut in the reserve ratio requirements by another 50 basis points. The Swedish Riksbank cut rates by 25 basis points and the Bank of England continues to buy back bonds. Says Joachim Fels of Morgan Stanley Research Global, “All this nicely supports our ‘Global Monetary Easing Part 2’ theme, which I continue to see playing out prominently during the first half of the year.”
As is apparent, the world’s central banks are printing their way out of a major economic crisis, just the way they did in 2009 and 2010. Even those central banks which have, so far, been reluctant to expand their balance-sheets have joined in the easing. After a global squeeze late last year, the world is flush with liquidity again. “Local banks are lending again, deleveraging by European institutions has slowed and investment funds are rapidly growing their assets in emerging markets,” explains Neumann. So, after gloomy projections last December, 2012 has opened on a positive note, with equities riding a fresh wave of quantitative easing.
While this may be good for investors, all this liquidity is going to have an obvious impact on inflation. Commodity prices, especially those of crude oil, have started heading up already. Prices of Brent are back to $120/bbl. And, though RBI has maintained an easing bias over the last few months, economists say we are fast nearing an inflection point in policy expectations. If this rush of liquidity persists and high commodity prices continue to fuel inflation to uncomfortable levels, the central bank may well have to delay its rate cut, which has almost been taken for granted over the last few weeks, after headline inflation fell below seven per cent. Neumann, therefore, believes easing might prove more limited than priced.
CLSA’s latest strategy report endorses this view even as it raises the Sensex’s target to 20,808. The report says returns will be “upfronted” on easy liquidity. However, “rising international crude prices and a possible increase in tax/fuel may delay the potential rate cuts by RBI. This could be a risk to market sentiments, which are building in large hopes on rate cuts”.