Macro & Markets - Diminishing returns from global liquidity ::Edelweiss (PDF link)

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Ample liquidity was on the offer by global central banks in February with BoJ, BoE, and ECB announcing QE programs. The much awaited second tranche of ECB’s LTRO met with tremendous response from EU banks but global markets were muted as asset prices had run-up in anticipation. Meanwhile, the domestic growth faltered in Q3FY12 although recent sequential trends in IIP, exports and PMI suggest that economy is gradually emerging from extremely weak phase of May-Oct 2011. On monetary side, unusually high liquidity deficit is a reflection of weak reserve money growth and CRR cut is becoming a certainty. On the valuations front, Indian markets are trading at fair levels, with downgrade cycle bottoming out.

Global economy: Outburst of liquidity

February saw major central banks- BoE, BoJ and ECB -announcing quantitative easing programs. The much awaited second tranche of ECB’s LTRO saw 800 banks tapping ~EUR529bn of 3-year funds. While LTRO has certainly helped boost liquidity and has taken the immediate tail risks off the table, it has not made any material improvement in the real economy. Also, we believe that LTRO-2 will have a diminishing impact given the sharp increase in asset prices in the run-up to the event.

Indian economy: Growth slows down

GDP growth slowed to ~6.1% YoY in Q3FY12 (against 6.9% in Q2FY12), led by very weak investment activity. However, sequential momentum in high frequency indicators – IIP, PMI, exports suggests that economic activity may be picking up gradually, although nature of the uptick in economic activity will much depend on the fiscal consolidation in FY13, pace of reversal in monetary policy and progress on the policy front.

Liquidity: Deficit at elevated levels

Throughout February, LAF borrowing remained at elevated levels before hitting all time high of INR1,900bn at one point. We think the primary reason for liquidity shortfall has been the very slow growth in reserve money, partly reflecting sizeable FX intervention by RBI to check INR fall. Liquidity conditions have eased in last couple of days but pressure is likely to persist, particularly with advance tax outflows coming in next couple of weeks. Accordingly, CRR cut is becoming a certainty.

Valuations: At fair levels, downgrades decelerate

After a scorching January, Indian markets took a breather in February. Net foreign inflows came in at USD7.1bn- the strongest ever on record for the first two months in a year. Valuations, meanwhile continue to trade at fair levels, both on absolute and relative basis. Earnings downgrade cycle seems to be stabilizing with just a little over 1% cut in Sensex EPS estimates in CY12 so far.

Macro & Markets - Diminishing returns from global liquidity