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This article was posted on Jul 2, 2011 and is filed under Market News

End of Quantitative Easing & Indian Equity Markets
When the Federal Reserve formally announced a second round of Quantitative Easing (QE) back in November 2010, most economists were convinced that further QE measures would threaten emerging market stability.

Where Did All The Money Go?

The Federal Reserve was heavily concerned that the recovery in the United States was far too weak; therefore, it decided to inject an additional $600 billion into the economy in the form of Treasury Securities purchases. The primary criticism that QE2 opponents held was that only a fraction of this $600 billion would actually reach the U.S. economy. Instead, critics argued that the additional capital would flow into emerging market economies as institutional investors sought higher yields.
In November 2010, many economists were concerned that massive inflation and asset bubbles could hit emerging markets during 2011 as all of this excess capital hit their economies. Although it is difficult to track exactly where what money goes, it is quite clear that emerging markets have not been as adversely affected by QE2 as some thought they might be. Sure, inflation is a concern in China, India, and Brazil, but the massive rally in commodity prices during 2011 has put definite pressure on those emerging market economies. India’s manufacturing and export sectors are paying much higher prices for raw materials because of the commodity boom, and this is dampening demand for its goods and services.

Commodity Boom and QE2

QE2 is set to be finished by June 30th. Now, it will take an additional period of time for the Fed to completely reduce its Treasury holdings, but no more purchases are planned after June 30th. What effect will this have on the U.S. economy and emerging markets such as India? There are differing opinions on this very question, but one very real possibility is that commodity markets will most likely continue to correct to the downside. Much of the QE2 liquidity excess has caused commodity prices to boom to All-Time Hi’s. This has, in turn, helped the S&P 500 rally over 25% since QE2 was initiated in November 2010.
Remember, we said that one reason emerging market equity markets, such as India’s NSE, have not rallied as strongly as the S&P over the last 9 months is because of the commodity boom. If commodities continue to fall in price, then emerging markets will benefit nicely as demand for their exports will most likely rise, and forex traders could begin to sell commodity currencies such as the Canadian dollar.

Inflationary Concerns

The doomsday predictions from November 2010 that hyped up the possibility of massive inflation in India are now discounted. It is clear that much of the excess liquidity never made into the NSE or other emerging market equity markets. This is a good sign. India is continuing to battle inflationary fears. The end of QE2 will most likely help the Indian economy continue to grow without the fear of rapid inflation taking over.
Indian Rupee
During 2009 and 2010, the rupee performed very well against the U.S. dollar and other developed world currencies that were maintaining extremely loose monetary policy. Now that the Bank of England, European Central Bank, and Federal Reserve are each continuing to tighten policy, albeit at a very slow pace, this should help continue to relieve pressure on the rupee, which tremendously helps the manufacturing and export sector. EUR USD has even began to correct as the end of QE2 approaches. A cheaper rupee makes Indian exports much more attractive in foreign trade, which, in turn, drives more capital into Indian companies and could help continue to push the NSE higher.

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