DRAGHI DOES NOT DISAPPOINT!

By Ruma Dubey

The Indian markets are lackluster and that is putting things mildly. With no trigger within the country, the markets have pinned expectations on Europe. The ECB meet and the announcement of Draghi had literally taken over all other news. Well, its good in a way ; at least it takes one away from the stalemate in the ongoing monsoon Parliament session, with Coalgate and quota war threatening to drown the country itself. And Draghi did not disappoint; he announced a stimulus and indeed, walked the talk. He has annoucned a slew of measures to buy bonds which is known as "Outright Monetary Transactions"

• ECB can undertake outright open market operations on secondary markets
• Bond purchases are unlimited
• ECB Bond buying will be done under conditionality
• Countries that want ECB to buy their bonds must first officially ask for help from Europe's bailout fund and agree to strict  and budget policy conditions
• Bond buys will be fully sterilized, meaning that the overall impact on the money supply will be neutral
• Will terminate programme when objective met
• Involvement of IMF will be sought
• Bond purchases may be terminated on no compliance
• Security Market Program (SMP) program is terminated, SMP liquidity will be drained
• SMP securities will be held to maturity
• No ex-ante quantitative limits
• Will publish weekly amounts of purchase
• Country wise monthly data
• ECB to conduct transaction if warranted
• ECB will target government bonds with maturities of one to three years
• If a country defaults, ECB would bear the losses

Expectations were high as Europe awaited ‘bond purchase’ news from European Central Bank (ECB) chief Mario Draghi. Just as last week, expectation was high that Bernanke would announce a QE3 at Jackson Hole, today, it was anticipated that the ECB will start a new bond-buying programme to help bring down the borrowing costs of Spain and Italy. On 26th July, Draghi had very famously said that he would do whatever it takes to preserve the Euro and that has been interpreted as more bond buying. And unlike Bernanke, Draghi did well!

He has proposed unlimited bond buying from the troubled European nations and hopes to bring down interest rates and thus lower nations’ borrowing costs. But this comes with some strings attached – as this is essentially about rescuing Spain, the country needs to work on erasing its budget deficit.

Bond buying was something which did not have the favour of Germany’s central bank, Bundesbank but it did not have enough votes on the ECB Governing council to prevent this. Bundesbank essentially felt that bond buying is equal to financing the nation’s Budget and hence opposed the move.

There were expectations of the ECB bringing down the benchmark interest rate from the current 0.75% to 0.50% and nothing happened there. But for Germany, which is growing, even 0.75% is low while for others like Spain and Italy and Portugal, even 0.75% is high. Thus inaction makes more sense with this lopsided growth in Europe currently. Also with all attention being taken over by the Bonds, interest rates barely got any time or attention!  Actually, the European markets were not expecting a rate cut which is why post the announcement, they did not react at all, keeping instead their eyes and ears peeled on Draghi’s bond buying plans.

The markets, as expected will be happy and it can once again look within as there are two important cues expected – the July IIP numbers on 12th Sept and the Credit Policy on 17th Sept.

Well, Bernanke, Draghi and Subbarao; Indian investors have indeed gone global with an eye on every central bank!