European Central Bank president Mario Draghi’s government-bond buying programme may not lift Europe out of its long stagnation—the rate of expansion in the PMI is the lowest Europe has seen in the past year and a half. There is also the view that what Europe needs, but cannot get, is fiscal expansion since it is the lack of demand that is the problem—huge structural rigidities in Europe also explain why the transition has been so long-drawn unlike in the US. Exports are a big driver of demand in Europe and, with the slowing of China, it looks like they will take a long time to come back—in just 3 months, the IMF has lowered its 2015 projection for trade growth by a fifth, to 3.8%. Even so, there is little doubt Draghi’s QE is probably the best shot the European Union has to get out of its current mess. For one, though there were some rumours over the last few days, the QE is a lot more aggressive than markets believed till some time ago, and that is why the euro has been falling faster against the dollar—from the time Draghi made the announcement till Friday evening, the euro had fallen 1.32% against the dollar. While the essential idea behind QE is to lower bond yields so much it forces investors into riskier financial assets, Draghi’s principal aim this time around was to weaken the euro to stimulate export-led demand. There is little doubt the decision that most capital losses from the bond purchases will be on the books of national banks and not of the ECB was a dampener, but if this buys Germany’s support, that may not be a bad thing. For one, the possible win for the Syriza in Greece, and its plan to restructure national debt, would have been weighing on the minds of German politicians. Two, given Eurozone inflation was negative in 2014, getting to a 2% target means a fairly long haul, so having Germany on board is critical.
Also, while the sceptics are right to argue monetary policy alone cannot lift Europe’s fortunes and structural reforms are the only solution, the important question is about what other choices Draghi had. He may not be able to change the mood of the markets as he did then with his ‘whatever it takes’ statement in July 2012, but keep in mind that, were Europe to slide into deflation, it would only aggravate the problems of highly-indebted countries.
The impact on countries like India will undoubtedly be positive since, if there is going to be double the amount of global liquidity created by central banks there was in 2014—$1.8 trillion in 2015 versus $910 billion in 2014 —some part of that is going to find its way into India. And while Indian earnings are being downgraded and its PEs are a bit on the high side, India continues to have the most favourable macros in the world—lower inflation and current account deficit and some growth pick up aided by some reforms—aside from the US. So, apart from an unexpected surprise, acche din will continue for the stock markets.