LTRO 2 - THE 'SICK MAN OF THE WORLD' GETS ANOTHER DOSAGE
By Ruma Dubey
The European Central Bank is pumping in half a trillion euros into the euro zone's troubled financial system for the second time. This might as well be the last such ‘stimulus’ but for now, it is being perceived as excellent news for emerging economies like India, China, Brazil and nowadays, even Indonesia. Europe is for now considered to be the ‘sick man of the world’.
The stimulus by ECB is in the form of €529.5 billion or US$712 billion money in cheap, three-year loans to 800 lenders. And by cheap rates, we mean really cheap, averaging at 1%. Banks have the option of paying back all or parts of the loans at any time after one year. What is being perceived by many in India is that LRTO is good news for emerging markets as many institutions will borrow at 1% from ECB and invests the funds in emerging markets where the returns will easily average between 7-8%. This is a no-strings attached kind of loan, meaning banks can invest or lend the money as and when and to whomsoever.
And when we talk of huge liquidity being pumped into the Euro zone, we mean really big. The total net amount of new liquidity as a result of the two batches of loans is about €520 billion. Though the emerging markets are excited about a large chunk of the money coming to them, one need to really try and understand how much percentage of this money will find its way at all into emerging markets, more importantly, into India.
When the first tranche of long-term refinancing operations (LTRO) was released, the banks then, used the funds to pay down their maturing debts. Some banks deposited the money at other European banks or with ECB itself, earning higher interest. Banks appear to have increased the percentage of assets invested in their own sovereign bonds. This time around, the 800 banks which received the money, also includes many smaller banks and the ECB is hoping that they will lend to start-ups, small businesses and individuals within Europe. It is expected that European banks themselves will require €360 billion to tide over their various financing needs. Thus the second tranche too, to a large extent will be used to buy into Govt bonds. Morgan Stanley expects Italian banks to buy a further €60bn in eurozone government bonds and Spanish banks could buy a further €25bn-€60bn.
But what we could see is an indirect positive impact – improvement in sentiments. The first tranche of LTRO came in Dec 2011 and one can say, rather naively that since then Indian markets have surged over 15%. Yes, this surge is mainly on account of FII inflows but how many FIIs or how much money came due to the LTRO is very difficult to gauge. Thus the second LTRO too would largely be used to support eurozone govt bonds but will once again help boost sentiment in equities and other assets.
Lloyds Banking Group has confirmed that it has drawn £11.4bn under the LTRO for an initial term of three years and it plans to use the funds to part-fund a pool of non-core euro denominated assets. RBS is also stated to be a borrower but the total borrowed is not yet known, though it had taken about €5bn of LTRO money in Dec.
The Indian markets will now gyrate to three tunes – Firstly, the RBI Policy on 15th March, then the Union Budget on 16th March and crude prices which could spike up after this second LTRO. Despite the dismal Q3 GDP, the mood remains largely optimistic. The LTRO helps in reinforcing this optimism further. FII money will come to India, as long as India remains attractive. But to hope that this Indian markets will benefit directly from LTRO is being too immature. Policy decisions in the Budget will either bring in more FIIs or drive them to better regions.