(MENAFN- Khaleej Times) Â The world is going to be inundated with torrents of dollars and euros in the hope that this incessant flood of liquidity will lift the economies of the US and the euro zone out of the morass of low growth, high unemployment, unnerving uncertainties and sagging confidence among consumers and businessmen.
In its latest (third) attempt to re-flate the US economy through quantitative easing i.e. printing money, the US Federal Reserve has announced that it will buy MBS (mortgage-based securities) securities worth $40 billion a month until the outlook for jobs improves substantially.
In addition, the Fed will continue with its Operation Twist (sale of short-term bonds while purchasing longer-term securities) until the end of the year and maintain near zero rates until mid-2015. Something similar has been happening in Europe. The European Central Bank has said it would buy sovereign debt with a residual maturity of up to three years.
The crucial feature is: the purchases will be unlimited. The markets across the world predictably responded very positively.
The impact of these measures on prices of the long-dated MBS bonds, stocks and commodities has been nothing short of stupendous.
In India, the upward movement in stock prices and bonds was aided by the sudden burst of reforms unleashed by the government to achieve a variety of economic and political objectives.
Experience suggests that this kind of monetary loosening is a short-term solution, much like a band aid on a broken leg. Its positive impact even on financial markets is short-lived. It does not lead to any significant revival of the real economy. Worse, by boosting commodity prices, it makes life harder for lots of other countries.
Printing of currency diminishes the worth of paper money and strengthens the alternative to the dollar i.e. gold. It creates speculative price bubbles in oil, food and other commodities. We have seen how QE1 led to a 60 per cent increase in oil prices over a period and how QE2 saw crude oil prices go up by 35 per cent.
This suggests that the effects of QE3 on India will be double-edged. In the short term, QE will increase risk appetite in the world's markets, and increase flows to emerging markets. That will support both the rupee and the Indian stock markets. However, given continued risks of policy implementation on the European side and with the 'Fiscal Cliff' in the US, sustained risk appetite is unlikely. In fact, stock markets have already reacted from the recent highs and so has rupee. On the flip side, there is no doubt that oil is headed upwards, taking many other commodities with it. High fuel prices will not only further stress the fiscal deficit, but also the current account deficit.
At the same time, QE3's impact on the real economy globally, and thus on India's export demand, would be limited.
The impact of the recent increase in diesel price would be washed out soon, so fiscal correction would remain elusive.
The prospect of increased liquidity worldwide and inflationary pressures of higher commodity prices will make it harder for Reserve Bank of India to cut interest rates. Indian manufacturing's recovery, too, is likely to be delayed by higher input prices. The punters may celebrate the stock market's gains; the government must watch out for the costs of the Fed's money-printing for India.
"The dollar is our currency but your problem," said the US treasury secretary John Bowden Connally, Jr. to a European delegation in 1971. Four decades later, it remains one.
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