A new stimulus

At a time when the US Federal Reserve is in the process of winding down ‘quantitative easing’ and hints it may raise short-term benchmark interest rates from the middle of 2015, the European Central Bank has done the opposite. It has slashed the main lending rate by 10 basis points to a record low of 0.05 per cent, while increasing the negative interest now payable on monies deposited with it by the same quantum to 0.20 per cent. Also, the ECB has announced its own version of QE, though this will mainly involve purchases of private sector asset-backed securities rather than government bonds as the US Fed chose to. A QE policy coupled with negative interest rates on idle bank funds parked with it will constitute an unprecedented loosening in the monetary policy of the ECB.

The reasons for doing so are obvious. Unlike the US, which registered a 4.2 per cent annual GDP increase in the second quarter, the European Union (EU) is unlikely to grow by even 1 per cent this year. It needs to combat persistently low inflation, which is running at below 0.5 per cent and is a serious drag on growth. The crisis in Ukraine, which has resulted in western sanctions on Russia and the latter responding in kind, is another growth dampener. If the period of low inflation prolongs much further — or worse, slips into deflation — there is the risk of an indefinite postponement of purchase decisions, worsening the prospects for growth and jobs. Given the ECB’s present commitment to ‘unconventional’ monetary measures until inflation rises close to its target of 2 per cent — a distant possibility now — one can expect the withdrawal of global liquidity from any policy tightening by the US Fed to be sufficiently compensated.

The ECB’s opening of the monetary spigot can benefit India. It is better positioned to take advantage of global money flows today, being more macro-economically balanced than before. We have a lower current account deficit ($7.8 billion in April-June versus $21.8 billion in the same year-ago quarter), a stable rupee, improved government finances (the Centre’s fiscal and revenue deficits are ruling below last year’s levels at this time) and steadily declining inflation. But macroeconomic and political stability are only necessary and not sufficient conditions for attracting global capital that chases yields. Capital will truly start flowing to India only when investors see growth returning. Further, they need to be convinced of the ruling government’s commitment to economic reform. Right now, there are only weak signs of both, but the Government is presented with an opportunity. It should lose no time in grabbing it to make India a compelling destination for global investors seeking higher returns.

COMMENT NOW