The good ship QE2 BRIC-ing it

The US Federal Reserve announced the launch of QE 2 on 3 November 2010. But it’s unclear if smashing the champagne bottle on the bow of the good ship QE2 will mark the launch of a successful voyage or tip the ship over a-la silent era film comedy.

QE or Quantitative Easing enables the Federal Reserve to inject money into the economy by purchasing government bonds. It is effectively printing money, but the purchases channel the money into the banks in the hope that a reinforced banking system will start lending to the wider economy.

Beyond the US, these policies are watched carefully by the governments and markets of the BRIC countries (Brazil, Russia, India and China). A key concern is that much of the QE2 money will land up on their shores in the form of Foreign Direct Investment (FDI) and portfolio investment, inflating local stock markets and creating an asset price bubble.

The concern is not unfounded. The OECD predicts that in the next two years economic growth in China will be about 10% per year, while India and Brazil are expected to grow at a rate of 8% and 4-5% respectively.  Compared with a paltry 2-3% growth in the US and the UK over the same period it is no wonder investors would turn to the BRICs for higher returns. The QE2 money may simply be invested in their stock markets.

But looking at the effects of the first round of QE, launched in both countries in March 2009, concerns of a BRIC asset inflation warrants some reconsideration.

The chart below shows FDI outflows from the US and UK, plotted agains FDI inflows into China, India and Brazil over the same period (data for Russia is unavailable). The data shows that while outflows did increase substantially in the quarters after the launch (in the US this happened sooner and lasted longer) the amount of inflows into the three BRICS was relatively muted.

Quarterly FDI flows 2007 - 2010
Source: data OECD

Furthermore, on an annual historical basis (see chart below) inflows to the three BRICs in 2009 were significantly lower than in the preceding two years.

Annual FDI flows 2000 - 2009 / OECD

Source: data OECD

Even though the data is incomplete it would suggest that QE may not have had as prominent an effect on FDI as the BRIC countries would like to think. It remains to be seen where the good ship QE2 will offload its cargo.

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About Gideon Benari
Solvency II Wire a site dedicated to informing professionals in financial services industry about Solvency II, the new regulation for the European insurance industry.

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