Coming soon a QE3, but will it go the Costa Concordia way? - Straight from the Hip by J Mulraj
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4 FEBRUARY 2012

Jim Sinclair argues that the US Government would soon introduce a third quantitative easing programme (QE3) in order to save the skins of the 5 major US banks. These banks have created, and sold, credit default swaps (CDS) on sovereign debts and hold some 95% of CDSs. These are, basically, insurance policies which trigger a payment in the event of a default by the borrower. Banks went overboard issuing CDSs in order to generate the profits that would permit payments of huge bonuses to their top managements.

The body that decides on whether a credit event tantamount to a default or not is called International Swaps & Derivatives Association (ISDA). ISDA is, of course, controlled by the same banks who own a majority of the CDSs. This is why ISDA was reluctant to term the 50% haircut taken by private investors in Greek debt a 'default', which would have triggered payments on Greek CDSs held by American banks. There is now talk of a further haircut, upto 70%, to be taken but Jim feels even that would not be labelled a default. Instead, he feels, the US Government would kick the can further down the road and introduce a third Quantitative Easing (QE3) programme.

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The Bank of England as well as the European Central Bank are also expected to announce further QE on Thursday.

Equity markets thrive on liquidity, and a part of the liquidity created through quantitative easing would find its way into stockmarkets. Perhaps the ongoing rally has been in anticipation of it.

However, the price has, sooner or later, to be paid. So QE3 may flounder, as did Costa Concordia, the Italian ship whose captain, Schettini is in the dock for bad piloting (pity his ship isn't). Likewise, it's doubtful if the heads of the US Fed, or of ISDA, would be in the dock when QE3 flounders.

Earlier efforts to stave off a Greek default included a $ 500 b. debt given to ECB which allowed it to introduce a programme to lend to European banks for 3 years at low rates, enabling them to buy more sovereign bonds, in order to lock into a float.

It is such injections of liquidity that have brought back global investors, who, basically, sit atop mountains of investible funds. The global pool of financial assets is over 3 times global GDP of $ 65trillion. This tends to 'flee to safety' in times of panic, and to come back into different assets, including emerging market equities, when the panic subsides, as it did with the ECB programme. Indian markets have rallied the most.

Last week they rallied 370 points on the BSE sensex, which went up to 17604, and 121 on the NSE Nifty, which ended at 5325.

This, despite the Supreme Court judgement cancelling the 122 telecom licences issued by former telecom minister, A Raja, on the grounds that proper procedural norms were not followed in the issuance. This is going to have several repercussions. The firms most affected, such as Telenor, which has invested heavily to acquire a 65% stake in Uninor, whose 22 licences are now cancelled, or Sistema Shyam, which holds 21, would take up the matter against the Indian Government in international fora. It would be difficult for the Government to claim in international fora that it did not have collective responsibility for the decisions. It would, of course, impact customers of the affected telcos, who would be denied service, and bankers to them. Some banks are asking the Government for a refund of the money they lent to telcos to procure the licences, now cancelled, and if the Government becomes liable to refund it, since the licences have been cancelled, it would further add to the fiscal strain. Customers can also expect a hike in call charges, by an estimated 30%. This is because of several reasons. Telecom companies have an aggregate debt burden of Rs 275,000 crores, which needs to be serviced. They have overpaid for 3G licences (Rs105,000 crores) which has not yielded a return. The Government has, after selling the 3G licences, prevented telcos from entering into agreements, as they have in 2G services, to share spectrum in circles where they do not have them. This allows the customer to have uninterrupted service. For no obvious reason the DoT has stopped this. It is also asking them to pay, retrospectively, charges for extra bandwidth.

Amongst those affected would be Etilsalat, which has lost licences in 15 circles of Etisalat DB. Prompting a wag to sing 'Raja ki jayegi Etisalat' to the tune of 'raja ki ayegi barat'.

Thus the much touted success story of Indian telecom has lost quite a bit of its sheen.

The Government also got flak from the Supreme Court for trying to compel its Adjutant General to alter the birth date of the Chief of Army, which would require him to retire a year earlier. The joke making the rounds is that whereas in India the Government decides the age of the Army Chief, in Pakistan its the other way around.

Core sector growth in December was up 3.1%, lower than the 5.9% in November, indicating a slowdown. It is thanks largely to the fall in output of gas from the KG basin, and would probably pick up when incentivised by a price higher than the $ 4.2/mmbtu fixed by the Government, which is far lower than the import price of competing products and acts as a disincentive to expolorators of gas.

The HSBC PMI (purchase managers index) is, contrarywise, up to 57.5, higher than the previous month, indicating higher confidence level.

So we are now at an interesting cross road. On the domestic front, the rally seems to have run out of steam, and we ought to see a downward correction. Elections have commenced in 5 states, and UP has recorded a voter turnout of 77%. The corruption scandals which erupt faster than Mount Vesuvias, forbode ill for the ruling Congress party. The fiscal situation, with ever increasing bills for various subsidies, do not give rise to optimism about the Union Budget, to be presented mid March.

On the other hand, the developed world, anxious to avoid a default of sovereign debt which would trigger payments on CDSs, 95% held by US banks, would try and buy their way out of trouble through QE. Being an election year in the US, a European crisis that threatens to be worse than the US crisis initiated by the collapse of Lehman Brothers, is an eventuality that they would seek to avoid.

The next instalment of Greek debt repayment is due March 20th. Would their Government be able to strike a deal before then? Another complication is the talk of an Israeli attack on Iran's nuclear facilities, to prevent them from making a bomb. The feeling is that were this to happen, it would be before spring. Incidentally, spring starts March 20th.

One should spring into action, and get a bit lighter.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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1 Responses to "Coming soon a QE3, but will it go the Costa Concordia way?"
Manmohan Khetan
Feb 5, 2012
Very good analysis Like 
  
Equitymaster requests your view! Post a comment on "Coming soon a QE3, but will it go the Costa Concordia way?". Click here!