Operation Twist: Fed delivers QE3 in different form

QE3 (quantitative easing part 3) has finally come through, but in a different form. This time nobody is cheering. Despite the failure of the previous bond-buying programme, the Federal Reserve, on Wednesday, announced its decision to sell short-term government debt (with maturities of three years or less) worth $400 billion to buy back long-term treasuries of the same amount from the market.  

Titled QE2, the previous bond-buying programme failed miserably and did nothing to create jobs. The new $400-billion bond-buying programme suggests long-term interest rates in the US will remain under pressure for at least another two years. The developed markets fell after the Fed’s announcement.

The move has spooked retail investors in developed markets further, as structural weakness in these countries is expected to continue. As financial markets go into a tailspin, crude oil should come down, experts believe. Risk aversion has resulted in investors pulling their monies out of risky assets, as there is no clarity on where the world is headed. Signs of risk aversion have been visible for some time now, but many have chosen to ignore it. CLSA has analysed the fund flow pattern from India-dedicated exchange traded funds, which shows ETFs have turned net sellers of $462 million during calendar year 2011, as against the overall FII net buying of $680 million in the secondary market (till August 31). The report says: "India-dedicated ETFs saw large outflows of $1.3 billion (May, June and August saw large outflows), partially offset by inflows from multi-country ETFs."

Experts say many in corporate India had seen this coming. They chose to defer capex plans and are now sitting on cash. Saurabh Mukherjea, head of equities, Ambit Capital, says this is one of the most predictable crises he has seen coming. The next three months will see complete pandemonium, he adds, during which the Sensex could go down to 14,500. It’s from this point a bottom could emerge, not before that.

This fall would probably even be justified, given that India is trading at 40 per cent premium to other emerging markets. Clearly, structural issues like inflation and governance deficit don’t support such valuations. As in any financial crisis, banking is the worst-hit and it is unlikely to be any different this time, too. At this point of time, there seem to be no beneficiaries of this crisis, not even the information technology sector. Corporate India, gotten used to seeing the rupee at 44-45 levels, will also see pain, as input costs will rise, along with payouts for those having external debt.

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