QE3 could boost Nifty to 5,550-5,600 in the short term

September 13, 2012

(The views expressed in this column are the author’s own and do not represent those of Reuters)

Indian markets have been buoyant since the European Central Bank’s decision on the unlimited sovereign bond buying program announced last week and the German Constitutional Court’s nod on Wednesday for the same.

The next trigger for the markets is the possible announcement of the third round of quantitative easing, or QE3, during the two-day U.S. Federal Open Market Committee (FOMC) meeting.

The moot question is whether Indian markets are having the BIRG (Basking in reflected glory) effect based on international cues. These global triggers act as steroids which can resurrect markets temporarily but sustaining them at higher levels would require domestic cues which have been missing for a long time.

Whether it’s the decision on the fuel price hike or reforms, the central government is not in a position to take concrete steps due to lack of political consensus even within the UPA. Scams are occupying their mind space and mitigating the effect on the 2014 parliamentary elections would be the primary objective of the incumbent government.

QE3, if announced, could lead to a knee-jerk reaction and Indian markets could give it the thumbs up with another 75-100 point rally on the Nifty. Looking back, the first round of quantitative easing with $1.25 trillion support saw the emerging markets, including India, experience a spirited rally which boosted both equity markets as well as commodities.

QE2 in November 2010 saw the injection of $600 billion but did not have the same effect with markets peaking out around the same time. My fear is that post-QE3, we could probably see the Nifty shooting up closer to 5550-5600 levels but this could be a temporary phenomenon, thus trapping hapless investors again.

The expected flow into equity markets may not keep pace as investment-worthy sectors such as healthcare and the consumer space already seem overbought with the valuation getting stretched. Any further up move will only increase the size of the bubble which is getting created. The other sectors may not evince much interest looking at the macro factors.

On the flip side, liquidity flows into commodities could jeopardise the interests of the manufacturing sector, which is already facing the crunch from a falling demand scenario. The flows into the debt market could also be muted as we are currently in a stable interest environment with an outer possibility of a rate cut. On the contrary, we had an increasing interest rate scenario during the announcement of QE2.

The QE3 will also raise concerns on higher inflation (read stagflation) which could lead to the continuation of the RBI governor’s hawkish stand on interest rates. Overall, QE3 from the Indian perspective could be described as short-term gain for a long-term pain.

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