The GFC in 2008 drove Central Banks across the US (the Federal Reserve) and Eurozone (European Central Bank) to embark on Quantitative Easing (QE) programs, something that Japan pioneered in 2001. Interest rates in Eurozone and Japan are now negative and we are clearly in uncharted territory. There has also been a lot of debate on efficacy of QE in achieving its objectives. With limited tools left in the central banks’ monetary policy toolbox, investors are getting increasingly skeptical of their ability to revive growth. In their turn, central banks too have become increasingly wary of unsettling markets.
The story is different for emerging market economies, especially India. In a growth-starved world, India shines like a beacon. While it does have its challenges in pushing through structural reforms and enforcing fiscal discipline, the International Monetary Fund (IMF) forecasts the economy to grow +7.5% in 2016 and 2017– the highest among major emerging economies. Lower oil prices and growing disposable incomes underpin this growth. Infrastructure, Manufacturing and Consumer sectors are likely to be key beneficiaries.
India's Monetary Policy Has Ample Room To Grow
In the US, the end of QE in October 2014 and the rate hike in December 2015 has arguably restored some tools to the Fed’s policy toolkit. But despite this, the US central bank continues to gingerly guide investor expectations via the language of its forward guidance. As such, it continues to shy away from surprising the markets.
Somewhere in between the BoJ and the Fed lies the policy toolkit of the ECB, which is currently relying on both the interest rate and QE channel to encourage bank lending. The ECB has been operating a negative deposit facility rate since mid-2012 and ramped up its bond purchases under the QE program to EUR80 billion from EUR60 billion in March 2016.
Fortunately, the policy toolkits of emerging market central banks are better equipped compared to their developed market counterparts. Specifically, central banks of emerging market giants like China and India have ample room to ease monetary policy to boost growth.
Emerging Market Central Bank Effectiveness: Setting The Cat Among The Pigeons
For China, 2016 is the first year of its 13th Five Year Plan for which it has set itself a target of around 6.5-7% GDP growth. Meeting this target in the context of the ongoing structural slowdown necessitates expansionary fiscal and monetary policy. The Peoples Bank of China (PBoC) for its part has been easing monetary policy since mid-2012, which was the time when “hard landing” fears became entrenched after nine successive quarters of decelerating GDP growth. The monetary policy tools at China’s disposal include possible cuts to the 1-year benchmark lending rate (currently at 4.35%) and required reserve ratio (RRR) of banks (currently at 17%). Premier Li Keqiang has denied that the country requires unconventional measures of monetary easing like QE.
Nevertheless, some of the targeted measures to boost bank lending have been described as “pseudo QE” or “QE by stealth” in some corners of the media. These include allowing banks’ loans and/or bonds held on balance sheets to be used as collateral for borrowing from the PBoC.
India's Economy Shines Like A Beacon
Unlike China’s economy that appears to be entering a new phase of slower growth, the Indian economy structurally possesses the capacity for sustained expansion. Much of India’s economic growth is domestically driven, which has helped to mitigate the drastic impacts of the 2008 financial crisis and the lacklustre external demand. India’s working population (as a share of total) will continue to grow for decades, which will provide a massive market for all kinds of goods and services. Rather than depend on exporting goods to other countries, India will itself provide a market to the exports of other countries.
This means that the Reserve Bank of India (RBI) has to tackle the problem of inflation, instead of the risk of deflation that has been besetting Japan, the Eurozone and now China. In this context, the monetary policy tools at the RBI’s disposal appear adequate –policy rate at 6.5%, cash reserve ratio at 4%.
Far from the need to adopt unconventional monetary policies like QE, the RBI has been urging the government to lower fiscal spending. The idea is to allow private consumption and investment to drive economic growth. Companies in Infrastructure, manufacturing and consumer sectors are likely to be key beneficiaries.
Lower oil prices are giving a further boost to rising disposable incomes of a growing middle class; which bodes well for retailers. Growing investments in public infrastructure is a big positive for key infrastructure sector players like Larsen & Toubro (500510-IN/LTORY-US). Banks such as ICICI Bank (IBN-US) and State Bank of India, which have strong infrastructure financing businesses, are likely to benefit as well.
Janki Sharma is a freelance economist based in Singapore and writes for Macrovue.
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