Two hoots to fundamentals; its all about liquidity these days

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Two hoots to fundamentals; its all about liquidity
Digest this simple fact. India's GDP for FY 13 (April 1, 2012- March 31, 2013), hit a decade low of 5 per cent, but, ironically FIIs invested a sum of more than Rs 140,000 crore in Indian equities in FY 2012-2103 - the highest ever.

This was largely on account of the fact that liquidity conditions were easy, with the European Central Bank (ECB) and the US Federal Reserve (Fed) pumping more money into their economies.

The Fed has been conducting what is known as an asset purchase programme or QE3, wherein it is pumping money to the tune of $85 billion into the US economy and this money finds its way into equities around the world, gold etc.

This drove Indian stock markets and emerging markets like Indonesia higher and helped fund their current account deficits, which ultimately supported their currencies. Interest rates in the US were near zero which further prompted these investors to look for better markets like India, where interest rates are far better.

Despite elevated inflation levels, slowing growth, weakening current account deficit and policy paralysis, foreign funds kept investing in India because they had ample money - they seemed to care two hoots for economic fundamentals. In fact, in May this year they invested a staggering Rs 22,000 crores in the Indian market, even as there were clear signs that Indian fundamentals were weakening.

Threats of liquidity tap tightening

When you have ample money, you will keep investing, no matter if the fundamentals are weak. You cannot keep money idle and have to make it work for you

Now, when there is a threat that the Federal Reserve in its policy meeting scheduled for Sept 18 and Sept 19, would reduce or taper off its asset purchase programme, Indian markets have dropped and the currency has fallen.

It's not that economic fundamentals have taken a turn in the last few weeks. They have been bad for the last several quarters. It's just that now there are threats that liquidity would be reduced as the Fed tapers off its asset purchase programme. This has hit our currency, which was being supported by foreign fund inflows.

For long foreign liquidity drove stock prices higher, and now less liquidity will drive it lower. Who cares a damn about fundamentals.

Read more about: gdp, inflation, qe3, federal reserve
Story first published: Monday, September 2, 2013, 8:54 [IST]
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