India's Manufacturing Industry Continues To Expand in September

Just following up briefly on my last post, as anticipated by the PMI report India's industrial production growth bounced back again in September. Output at factories, utilities and mines rose 4.8 percent from a year earlier after a revised 1.4 percent gain in August, according to data from the Central Statistical Organization today (Wednesday).



India's factory output rose 4.9 percent in the six months to September from a year earlier, less than half the 9.5 percent pace recorded in 2007, according to today's report.

And the expansion in Indian manufacturing looks set to continue into October according to the latest ABN AMRO Bank purchasing managers' index (PMI) report. The index, which isbased on a survey of 500 companies, slumped to a seasonally adjusted 52.2 in October, its lowest since the survey began in April 2005 and sharply below September's 57.3. A reading above 50 signals expansion while a figure below 50 suggests contraction, and the manufacturing PMIs are interesting, since they do offer us a sort of "real time" snapshot of what is actually happening.

As Inflation Continues To Fall Back, Is The Indian Economy About To Take Off Again?

Indian inflation fell back again in the last week of October, as energy and commodity prices continued to fall, and the impact of the global financial turmoil and credit crunch ricocheted its way across one country after another. The IMF last week forecast annual growth for India of 6.3% in 2008 while India's manufacturing expansion, which continued to weaken, still held out against the global trend, according to the latest JPMorgan global manufacturing PMI.

So, as we enter November, and a number of Indian indicators start to improve, it is certainly worth asking ourselves, has India turned the corner? Will India lead the emerging markets charge during the next global expansion?

I am not, I am sure, alone in feeling that this is a distinct possibility, and, indeed, a similar view was expressed only last week by Sharmila Whelan, senior economist at CLSA Asia-Pacific Markets.

``We do expect the Indian business cycle to be the first to bottom in Asia. And, it should, in theory, be first to emerge,'' Sharmila Whelan, senior economist at CLSA, said ``The worst will be over by mid-2009 and by 2010 you should be able to see the next investment-led business cycle taking root.''

To the two reasons Wehlan offers us as an explanation for why we should expect India to do better than most (and, perhaps of particular nore here, better than China) - the fact that Indian trade constitutes only about 32.5% percent of gross domestic product (only about half the China figure - thus India is better protected from fluctuations in global trade) and the fact that India (unlike say Russia or Brazil) will be a large net beneficiary from falling commodity prices - I would add a third, India's very favourable demographic profile, which will mean that over the next decade India can continue to draw on the benefits of a young and rapidly growing labour force at just the time when 30 years of once child per family policy starts to bite really hard on the new labour market entrant cohorts in China (for example).

Inflation Screeches To A Halt

India's inflation held near a five- month low at the end of October, seemingly validating the central bank decision to reduce interest rates to bolster economic growth. Wholesale prices were up 10.72 percent in the week to Oct. 25 from a year earlier after gaining 10.68 percent in the previous week, according to the latest data from the commerce ministry.


Of equal importance is the fact that the weekly rate of inflation (week on week) recently turned negative, as energy and commodity prices drop back, and as a result the wholesale price index has now been dropping for eight consecutive weeks after peaking in the August 30 week.



One of the reasons inflation is weakening is of course the fact that Indian GDP growth has been slowing, and the current growth rate is clearly significantly below the 7.9 per cent rate registered in the second quarter (2008 calendar year) a rate which was already notably lower than the 8.8 per cent one reported for the January to March quarter. But with countries from the US to Germany, to Russia and maybe even China (who knows at this point) falling into or near to negative growth, then even a 7% rate looks decidedly healthy to me. What was it they were saying not so long ago about "Hindu growth"? Better a tortoise than a hare in some contexts, but then again, a 7% tortoise is certainly no mean one.




It is interesting to note in passing that the IMF - in revising their forecast down to 6.3% for 2008 - stated that they consider this level to be considerably below India's potential growth. For the time being, it seems, the old "overheating" debate has become a thing of the past. These days we all love India, now don't we?

Ironically, the current global situation is also making India's measured pace of economic reform look wiser than before. At a time when Western countries are frantically nationalising banking assets, the Indian government's reluctance to sell more than 49% in its state-owned banks—which control some 70% of banking assets—now seems reassuring. In addition, India has not yet introduced full capital-account convertibility, which protects its currency, while its careful control of foreign borrowings by domestic companies limits dependence on the global financial system. Regulators have also periodically introduced curbs to slow the formation of potential asset bubbles, such as higher provisioning and prudential requirements on real-estate lending.
The Economist

“For India we have marked our forecast down to 6.3% of 2009 calendar year. That is considerably below what we consider to be India’s potential growth,” IMF deputy director for Asia Pacific region, Kalpana Kochhar said. “There is a specific meaning to “potential” - it is the rate at which you can grow without causing inflation. And for India we estimate that to be 7.5% to 8%. Our forecast of 6.3% would put it quite a bit below the potential,”.

Obviously there are still varying forecasts, with the RBI and the central government being rather more optimistic than most, although India's central bank did reduce its growth forecast on October 24 down to 7.5 percent from 8 percent for the year to March 31. This prediction, if fulfilled, would mean the 2008/09 expansion would be the slowest in four years, but then in the midst of the largest global recession since the 1930s that doesn't sound so bad, now does it?


Interest Rates Coming Down and Monetary System Stabilising

The Reserve Bank of India cut its benchmark rate on Nov. 1 for the second time in two weeks, joining policymakers across Asia in lowering borrowing costs to shield their economies from the global financial crisis. For the first time since 1997, India's central bank on Nov. 1 deployed all three of its main tools to shore up growth after inter-bank lending rates climbed to as much as 21 percent. The move seems to have substantially improved liquidity in the financial system, and overnight call rates fell sharply.

The Reserve Bank of India lowered its benchmark repurchase rate to 7.5 percent from 8 percent. At the same time the central bank also reduced the cash reserve ratio to 5.5 percent from 6.5 percent, and and cut the amount of money lenders are required to keep in government bonds to 24 percent from 25 percent.



The RBI is also considering giving an additional 100 billion rupees ($2.1 billion) each as lines of credit to National Housing Bank and Small Industries Development Bank of India, according to Finance Minister Palaniappan Chidambaram speaking during last week. The idea here would be to increase cash flows for mortgages and for small companies.


Rupee Rises Slightly



The rupee climbed 3.8 percent last week to close at 47.66 a dollar at the 5 p.m. in Mumbai on Friday. The increase represents the biggest weekly gain since March 1996, making the rupee currently the best performer among Asia's 10 most-active currencies outside Japan.



In addition on the foreign currency front, the Japanese Yen is also dropping back slowly against USD, which means that yen "carry" may be slowly starting to recover. A surge in USD-Yen (and hence yen carry) would be another clear sign some key emerging markets we about to start moving, in my view. As we can see from the chart - unless we have more "turmoil" to cope with moving forward - October 24 seems like it represents some kind of turning point.




Stocks Start To Tick Up Again


The Bombay Stock Exchange Sensitive Index has also rebounded, and is up 17 percent since the bottom on Oct. 27. The index added 2.4 percent on Friday. The MSCI core index for India is also up 6.74% so far this month. After all that falling over the last twelve months, it is that little upturn since the start of November (see chart below) that we would like to see consolidate and continue. Of course, this may be yet another false start, and there may be another shoe to drop, but perhaps there are reasons for just a little more optimism at this point.




And the general MSCI Emerging Markets Index also looks as if it may well have turned.





Emerging Bonds Start To Rebound Too


Emerging market bonds have also started to recover, if we look at the JPMorgan EMBI+ chart, we can see what appears to be quite a robust "bounce back". Of course for some countries (Eastern Europe, Argentina etc) the worst is still not over, but India may well be relatively insulated from too much fall-out here.





Not Much Sign Of A Rebound In Commodities Yet

On the other hand, with growth in the OECD countries likely to be bordering on negative in 2009, and Russia and China both likely to have substantial slowdowns, there are not too many signs at this point of any recovery in commodities, if we look at the Reuters-Jefferies chart.




But since India is a large net commodities importer, this is hardly bad news. Oil prices were sedentary Friday following a large scale sell-off during the week, - and this despite a forecast from the International Energy Agency that put the price of crude at $200 per barrel by 2030. Light, sweet crude for December delivery rose 27 cents to settle at $61.04 a barrel on the New York Mercantile Exchange, although the contract had dropped below $60 in earlier overnight electronic trading for the first time 19 months. This is all now a far cry from June, when oil was trading at $147.

India's Foreign Exchange Reserves Continue to Fall

India's foreign exchange reserves declined again at the end of October - for the sixth consecutive week - and fell by $5.532 billion to reach $252.883 billion for the week ended October 31. India's reserves have fallen by more than $31 billion in the past one month alone, and are now well below their $318 billion April peak. But on the other had they are still substantial and not far different from what they were 12 months ago, following a very substantial rise over the previous nine months. So if they do not fall too much further, then it isn't evident that there is any real problem at this point.

Sustained dollar selling by the Reserve Bank of India in the forex markets, huge amounts of FII outflow from the domestic equity markets, and the revaluation of the reserves have been the main factors pressurising India's reserves, but all these factors are symptomatic of the general pressure which has come to bear on "higher risk" emerging market economies as a whole as the financial turmoil and associated uncertainty have raged in the United States and Europe, and there is little real evidence of "India specific" factors at work here, indeed Indian exceptionalism would rather be in the fact that - absent commodity export dependence - India's reserves have not been taking the same sort of pounding Russia and Brazil's have.




The Reserve Bank of India (RBI) also said on Friday that it will lend foreign exchange - via foreign excahnge swaps - to banks with overseas operations to help them meet their lending requirements, a move that many Indian banks had been asking for, and which should help ensure adequate funding for their foreign subsidiaries. Following the central bank’s announcement, banks will buy dollars from RBI at the reference rate plus three-month forward premium and will return dollars to RBI after three months, in case of three month swaps.

Additionally, the central bank has also extended a lifeline to banks for funding the swaps by allowing them to borrow through its regular liquidity adjustment facility (LAF). The LAF is the window through which it lends to or accepts money from banks, for the corresponding period at the prevailing policy rate.

Banks borrow through the LAF window by pledging government bonds. They are required to invest at least 24% of their lendable funds in government bonds; this portion of their deposits is called the statutory liquidity ratio, or SLR. In view of the tight liquidity conditions, RBI reduced the SLR by 1% to 24% on 1 November. RBI also said on Friday that if a bank did not hold enough government securities to pledge, it would consider relaxing the SLR requirement if the bank approached it.

The use of swaps helps banks obtain cheaper funds for buying dollars because they can now borrow from the central bank repo window at 7.5%. Previously banks needed to convert their rupee deposits - raised at a rather costlier 10.5-11% - into dollars.


India's Industry Resists The Global Slowdown


Despite the fact that India's industrial output plummeted to a 1.3% year on year rate in August, there are some signs that the situation may be improving. The first of these are the September performance indicators for the coal and cement sectors, the rise in which pushed up the growth in output in the core infrastructure industries to 5.1% in September. According to government data made public on Friday, coal production was up by 10.7% in September 2008 while cement production rose by 7.9%.



Core sector growth in August was just 2.3% - and the six core industries have a weight of 26.7% in the index of industrial production (IIP). On the other hand growth in electricity generation remained weakish - at 4.4% - in September. If compared with the growth rate in August this year, electricity generation was the worst performer among the six sectors, with an abysmal growth of 0.8% in August 2008. Of the six core industries (crude oil, petroleum refinery products, coal, electricity, cement and finished carbon steel), only coal and cement really registered strong growth rates in September 2008. So I guess we have to wait till mid-week now to see the complete September figures.

However, despite what may well turn out to be an improvement in September IP over the August number, it does looks very much as if activity at Indian factories fell to its lowest level in three and a half years in October as the global financial crisis and slowing export demand hit the country's manufacturing sector. The ABN AMRO Bank purchasing managers' index (PMI), based on a survey of 500 companies, slumped to a seasonally adjusted 52.2 in October, its lowest since the survey began in April 2005 and sharply below September's 57.3. A reading above 50 signals expansion while a figure below 50 suggests contraction, and the manufacturing PMIs are interesting, since they do offer us a sort of "real time" snapshot of what is actually happening.

"The outlook for the manufacturing sector appears to be bleaker in the backdrop of tough local and global economic conditions," said ABN AMRO Bank N.V. senior economist Gaurav Kapur.

So the point here would not be that Indian industry is in absolutely perfect condition (it is obvious that it isn't), but rather that, at a time when global manufacturing generally is taking a huge beating, Indian industry is hanging on in, by its fingernails, but it is hanging on in.

In comparison, the JPMorgan Global Manufacturing PMI posted 41.0, its lowest reading since data were first compiled in January 1998 and a level below the no-change mark of 50.0 for the fifth month in a row.

Output, total new orders and new export orders all contracted at the fastest rates in the survey history in October. With the exception of India, which again bucked the global trend, all of the national manufacturing surveys posted declines in output and new orders. The impact of the downshift in global market conditions also had a far-reaching effect on international trade volumes. Although new export orders fell at a slower rate than total new business, all of the national manufacturing sectors covered by the survey (including India) saw a reduction in new export orders.

"October manufacturing PMI data reinforce the stark retrenchment that the sector is currently facing, with production, total new business and new export orders all falling at record rates. The latest Output Index reading is consistent with a fall in global IP of almost 8%. The only positive from the surveys was a decline in input prices for the first time since August 2003."
David Hensley, Director of Global Economics Coordination at JPMorgan

Returning finally to India, perhaps somewhat significantly the export order index in the PMI survey contracted for the first time in the survey's history, coming in at 49.7 in October, compared with 53 in September. Manufacturers blamed poor global financial and economic conditions for the result. But this should not surprise us too much either, since India's exports grew at their slowest pace in 18 months in September. Overseas shipments, which constitute about 15 percent of the Indian economy, were up 10.4 percent (to $13.7 billion) from a year earlier, following a 27 percent gain in August. Imports also increased - by 43.3 percent to $24.4 billion, with the result that the trade deficit widened to $10.6 billion.

``The global financial and economic headwinds adversely affected foreign demand for Indian manufactured goods,'' said Gaurav Kapur, an economist at ABN Amro Bank in Mumbai. ``The growth of total incoming new work to the Indian manufacturing economy lost considerable momentum.''

So, in conclusion, I am not saying that everything in the Indian garden is simply perfect, rather I am simply pointing out that during times which are hard for everyone, India has some advantages to lean back on, and looks set to have a lot less serious downturn than many other emerging economies may experience. So to end, almost where I started, with CLSA'a Sharmla Whelan, I do expect the Indian business cycle to be the first to bottom in Asia, and I would most certainly agree that "it should, in theory, be first to emerge".

Credit Tightening Continues as Inflation Falls Back Steadily

Inflation is no loger the greatest threat to the short term health of the Indian economy. The global credit crunch has now taken over poll position on the list of worries which are likely to determine the evolution of policy over at the Reserve Bank of India. India's inflation continues to slow and hit a four-month low at the start of October, giving the central bank room to keep injecting cash into the financial system without fanning prices.

Wholesale prices rose 11.44 percent in the week to Oct. 4 from a year earlier after gaining 11.8 percent in the previous week, according to data from the commerce ministry last week.

Weaker price gains and a shortage of money in the banking system have allowed the central bank to shift its focus from fighting inflation to stimulating an already slowing economy. The Reserve Bank of India on Thursday lowered the amount of deposits that lenders need to set aside for the second time in a week to ease the worst cash shortage in the economy since 2000. The central bank reduced its cash reserve ratio to 6.5 percent from 7.5 percent, a move which will add 400 billion rupees ($8.2 billion) to the financial system. India also accelerated loan payments to banks and doubled the overseas investment limit in corporate bonds to shore up the rupee from near a record low. Until the reduction in the cash reserve ratio which started just over a week ago now the Reserve Bank had increased its repurchase rate by 3 percentage points to 9 percent since 2004 and the cash reserve ratio by 4 percentage points since December 2006. The central bank's next monetary policy statement is due to be released in Mumbai on Oct. 24.

India thus joined Brazil and Russia in injecting funds into commercial banks to tackle the global credit crunch, this is viewed to be a less riskier route at this point than intrioducing interest rate-cuts, and it is hoped it may also prove to be a more effective way of getting liquidity quickly through to the corporate sector.

India has injected one trillion rupees ($21 billion) through reserve requirement cuts since Oct. 11 as call money rates surged and mutual funds sought government help to meet the highest redemptions by investors this year. The central bank's moves to inject liquidity helped push down India's call rates to 7 percent today from an 18-month high of 16 percent hit on Oct. 10.

Finance Minister Palaniappan Chidambaram also increased interest rates on deposits by non-resident Indians and doubled the overseas investment limit in corporate bonds to $6 billion to shore up the rupee from near a record low.

The extra yield investors demand to own developing nations' bonds instead of U.S. Treasuries fell 17 basis points to 6.06 percentage points, according to JPMorgan Chase & Co.'s EMBI+ index. The yield on bonds rises, as the value of the underlying bond falls.

Oil and Commodities Continue To Fall

Oil prices recovered some ground Friday, rallying above $71 a barrel on speculation that OPEC could slash output in an effort to stop crude's downward spiral. Light, sweet crude for November delivery rose $2 to settle at $71.85 a barrel on the New York Mercantile Exchange after earlier rising as high as $74.30. On Thursday, prices lost $4.69 to settle at $69.85 a barrel. Despite Friday's modest rally, oil is still down $75 — or 51 percent — since catapulting to a record high of $147.27 on July 11.




Commodity prices fell during a volatile week, with the Reuters/Jeffries CRB Index of 19 raw materials from coffee to silver, dropping 3.6 per cent amid concerns that the global economy was heading into recession. The abrupt falls in commodities - the RJ-CRB index hit its lowest level in four years - engulfed gold , which ended yesterday at a one-month low of $775 a troy ounce,



Steel prices as also falling rapidly, as industrial and construction demand drops sharply. Tata Steel Ltd., India's biggest steelmaker, has announced itwon't raise prices for six months or cut output if the government imposes an import tax and scraps levies on exports of the metal.

Companies are seeking 15 percent import duty and scraping of the export levy as demand weakens, Minister Ram Vilas Paswan told reporters after meeting executives in New Delhi today. They also want excise tax to be lowered to 8 percent from 14.4 percent.

Slowing demand from manufacturers and builders is driving down steel prices and forcing producers including ArcelorMittal, and Corus, the U.K. unit of Tata, to consider output cuts. Global steel production and consumption may slump 5 percent in 2009, Research & Consulting Group AG said Oct 9.

Foreign Exchange Reserves


India's foreign exchange reserves fell $9.94 billion during the week ending October 10, 2008 to $274 billion mainly because the Reserve Bank of India continued to sell dollars to try to contain the steep depreciation of the rupee.Forex reserves fell by another $9.93 billion (to $274 billion) during the tumultous week ended October 10, 2008 following the $7.8 billion fall of the previous week. .

India — the fourth largest holder of foreign exchange reserves in Asia after China, Japan and Taiwan — has seen reserves sliding since the start of this fiscal year. Since hitting a peak of $316.17 billion during the week ending May 23 this year, reserves have dropped by $42.17 billion. , forcing policymakers to unveil measures such as higher investment limit for foreign institutional investors (FIIs) in corporate debt and allowing banks to offer higher rates on NRI deposits to boost inflows. The situation now stands in stark contrast to the same period a year ago, when reserves rose by $57 billion.


The revaluation of the foreign currency assets also contributed to the steepest-ever weekly fall. In the previous week foreign exchange reserves had declined by $7.8 billion, which was also a weekly record. Overall, reserves have fallen by nearly $18 billion in a fortnight.


In rupee terms, India's foreign exchange reserves, however, rose by Rs 2,258 crore during the week ending October 10 to Rs 13,33,424 crore. In the financial year, the increase is to the tune of Rs 95,459 crore. India's merchandise exports, which were estimated at $250 billion in 2007-08 are, for the time being, well covered.

In recent months, foreign institutional investors (FIIs), which are facing financial pressures at home , have been selling in the Indian markets and repatriating money. In calendar 2008 so far, FIIs have been net sellers of $10.83 billion in the equity market. FII sales have put pressure on the rupee, which has dropped 22.96 per cent against the dollar since January. This has prompted RBI to intervene heavily in the forex markets.





Stocks Fall

Indian stocks fell, with the benchmark Sensitive Index declining to its lowest in more than two years on speculation that overseas funds faced with redemptions are selling the nation's equities. Reliance Industries Ltd. tumbled 6.2 percent to its lowest since March 16, 2007. Infosys Technologies Ltd., the software developer that gets more than half its revenue from the U.S., fell 4.8 percent to its lowest in three years.

The Bombay Stock Exchange's Sensitive Index, or Sensex, fell 606.14, or 5.7 percent, to 9,975.35, its lowest since June 20, 2006. The benchmark posted its fourth weekly decline, falling 5.3 percent. All 30 stocks in the index dropped. The S&P CNX Nifty Index on the National Stock Exchange dropped 194.95, or 6 percent, to 3,074.35. The BSE 200 Index lost 5.1 percent to 1,201.95.

India's MCSI Core Stock Index was down 4.45% on the day on Friday, after falling 26.7% so far this month, and 63.44% so far this year. But India is far from alone here, since the MSCI Emerging Markets Index plunged by 28 percent this month, with Russia's Micex Index alone falling 42 percent.





Overseas investors sold a net 8.41 billion rupees ($172 million) of Indian equities on Oct. 15, increasing the outflow this year from stocks to a record $11.1 billion, according to India's stock market regulator.


The Rupee


India's rupee fell to a six-year low as the benchmark equity index slid below 10,000 for the first time since June 2006, stoking concern capital outflows will quicken. The currency completed a 10th weekly loss. The rupee in part dropped on concern measures taken by global central banks and governments won't be enough to stave off the credit crisis.

The currency fell back0.8 percent this week to 48.8825 a dollar at the 5 p.m. close in Mumbai. That is the lowest since June 2002. The currency's 10-week losing streak is the longest since December 2005. The rupee has fallen 19.4 percent this year, the most since a balance-of-payments crisis in 1991 forced the nation to pawn its gold with the International Monetary Fund to pay for imports. It is poised for the first annual loss since 2005 as overseas investors pulled out almost two-thirds of the record $17.2 billion they invested in Indian equities in 2007.



Disclosure Statement: Edward Hugh is a macroeconomist who maintains a premier set of blogs at Global Economy Matters and is a featured analyst at Emerginvest. Edward Hugh provides non-partisan information about world stock markets, and does not have any holdings in foreign equities. The information stated above should not be construed as investment advice, and Edward Hugh is not liable for any actions taken on said materials.

India's Ship IS Battered By The Global Storm, But She Will Survive!

by Edward Hugh: Barcelona

India is in the middle of a storm at the moment, there can be no doubt about that. But the important point to note is that this storm is not of India's making. The financial turmoil in a number of key developed economies, and above all the United States, is sending shock waves across the global economy, and as is normal, when the earth trembles, it is the most fragile who notice it most. India's economy may be fragile in the sense that it is very vulnerable to what is colloqially known as global risk sentiment, but it is not fragile in terms of being susceptible to having its growth trajectory knocked completely off course. India may be shaken, but her economy will not be broken.

Emerging Market Bonds

Emerging-market bonds had their worst week in four years this week as the deepening credit crisis raised global recession concerns and slammed the brakes on demand for higher-yielding securities. The extra yield investors demand to own developing-nation bonds rather than U.S. Treasuries surged 62 basis points, or 0.62 of a percentage point, this week to 4.41 percentage points, according to data derived from the JPMorgan Chase EMBI+ index. The increase is the biggest since May 2004 and leaves the so-called spread at its widest since June of that year. The spread has now swelled 1.42 percentage points since the end of August.

Investors remained wary of emerging-market debt as evidence mounted that most of the major major economies - the U.S., the UK, Japan and the Eurozone - are sliding into recession. This realisation has triggered a major exit from commodities, which are a significant source of export revenue for a large number of developing nations. In particular bonds extended losses on the perception that the $700 billion U.S. bank bailout would not work miracles and thus many developed economies will be struggling to digest the impact of the credit blow-out for some time to come.


Until credibility is restored, we will not see people investing in the numbers that emerging economies like India and Brazil badly need to see. But at the same time, we might ask ourselves, at theis moment in time if they don't invest in India and Brazil, then where are they going to invest? The problem is that in the present global environment people are not simply not willing to take assume what is perceived as "risky" without being paid a large - and from the emerging economy point of view - damaging premium. Of course, the situation is also confused since people are no longer clear what constitutes "risky" and what doesn't - the German government, for example, yesterday found itself forced to offer a blanket guarantee of all domestic bank deposits to head off any risk of flight from German bank accounts.

One result of all this nervousness is that the cost of protecting developing nations' bonds against default has been steadily rising. Five-year credit-default swaps based on Argentina's debt climbed 44 basis points to 12.55 percentage points last week, the highest since at least June 2005. That means it costs $1.255 million to protect $10 million of the country's debt from default. Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.


Emerging Market Stocks

Emerging-market stocks also fell substantially last week, experiencing their the biggest weekly decline in seven years, led by the banks and energy companies. The MSCI Emerging Markets Index dropped 2.3 percent on Friday to 741.73, following a 3.4 percent decline on Thursday. The index lost 10 percent on theweek, the most since the September 2001 terrorist attacks.


Turkey's benchmark index fell the most in three weeks, losing 4.2 percent to 34,553 in the first trading day since Sept. 29. Russia's Micex Index slumped 5.3 percent, extending its annual loss to 51 percent. India's Sensex index slid 4.1 percent to 12,526.32. Reliance Industries Ltd., India's biggest company by market value, slumped 7.6 percent, to its lowest in a year.

Inflation Falls

But while India's financial system has been taking a beating, Indian inflation, almost un-noticed -slipped back to a 13-week low in late September, giving the central bank some breathing space to keep interest rates unchanged and lossen the liquidity strings when it next meets at the end of this month. Wholesale prices rose 11.99 percent in the week to Sept. 20 from a year earlier after gaining 12.14 percent in the previous week, the commerce ministry said in a statement in New Delhi on Thursday.



Reserve Bank of India Governor Duvvuri Subbarao is under pressure to boost money supply as a local stock sell-off triggered by the global credit crunch has drained funds from the banking system, increasing borrowing costs. Subbarao will undoubtedly seek to steer a middle course, since, given that inflation is still double the central bank's target he will not want to seem to be "soft", while on the other hand he will want to be prudent and will try to head off an excessively rapid credit tightening on the back of the global crunch. In addition, the peak of global inflation has now undoubtedly past, and we are now likely to see growing deflationary (rather than inflationary) headwinds as capacity levels exceed demand across the whole global economy and commodity prices tumble, as Claus Vistesen explains in this excellent and timely post.

The Indian central bank had been busy tightening, and had raised the cash reserve ratio, or the proportion of deposits that lenders maintain with it as reserves, by 400 basis points to 9 percent during the period between December 2006 and July 2008 in an ongoing battle to contain inflation. The bank will make the outcome of its next meeting in Mumbai known on Oct. 24, but we can be pretty sure that the "bias" will now have shifted towards loosening liquidity conditions rather than tightening them, as the priorities have changed, and the big priority now is to avoid any systemic bank problems, to keep the cost of borrowing for Indian companies down, and to prevent consumer credit slowing too dramatically.

The Indian banking system has been under increasing strain in recent days, and one symptom of this is that the rate at which Indian banks lend to each other reached an 18-month high of 17.5 percent on Oct. 1. Indian banks borrowed an average 413 billion rupees a day from the central bank in September, almost twice the amount in August, further indicating a shortage of funds in the banking system.


Commodities Down

Commodities, as measured by the Reuters/Jefferies CRB Index of 19 raw materials, tumbled 9.9 percent last week, the most since at least 1956.

Crude oil has lost 12 percent during the week, the most since 2004. The contract for November delivery traded at $94.47 a barrel, up 0.5 percent, as of 12:11 p.m. London time. Copper fell as much as 3.1 percent to $5,670 a ton on the London Metal Exchange, the lowest since February 2007 and was down 12% on the week.

Such downward movement in commodity prices has a double-edged impact on emerging economies. On the one hand inflation, which has in large part been driven up by rising commodity prices, will reduce significantly, but on the other hand many emerging economies are dependent on revenue from commodity sales to finance growth and development. Really this is a situation which will sort the "men" from the "boys", since those emerging economies which are really going to emerge will be in a position to switch the driving force of growth from commodity and agricultural dependence to industrialisation and domestic investment and consumer demand. It is my firm belief that India is now decidedly inside the group which is in the process of making this transition.


Stocks Down

Indian stocks fell during the week, with the benchmark Sensex stock index declining to its lowest in 18 months. The Bombay Stock Exchange's Sensitive Index, dropped 529.35, or 4.1 percent, to 12,526.32, its lowest since April 2, 2007. The index posted its second weekly decline, falling 4.4 percent. The S&P CNX Nifty Index on the National Stock Exchange fell 3.4 percent to 3,818.30. The BSE 200 Index declined 3.8 percent to 1,515.29. Nifty futures for October delivery fell 2.9 percent to 3,853.


Overseas investors bought a net 845 billion rupees ($18 million) of Indian stocks on Sept. 30, trimming their net outflow this year from equities to $9.1 billion, the nation's stock market regulator said.


Forex Reserves

India's foreign exchange reserves fell marginally by USD 153 million to USD 291.819billion for the week ended September 26 from USD 291.972 billion in the previous week. Reserves had jumped by USD 2.511 billion in the previous week. Foreign currency assets (FCA), during the week, dropped to USD 282.652 billion from USD 282.811 billion a week ago, according to data issued by the RBI on Friday.

Rupee

India's rupee slumped to the lowest since 2003, adding to speculation investors will take continue taking money out of the currency. The currency completed its eighth weekly loss, the longest drop since December 2005. The rupee was down 1 percent on the day to 47.085 per dollar, the lowest since June 2003, as of the 5 p.m. close in Mumbai on Friday. The currency lost 1.15 percent this week.

September Global Manufacturing PMI Shows Sharp Contraction

September seems to have been the ultimate "mensis horribilis" for industrial output internationally - and thus it is only natural to assume that Indian industry was also adversly affected - with global manufacturing activity contracting for the fourth consecutive month, and output falling to its weakest level in over seven years according to the JP Morgan Global Manufacturing PMI, which at 44.2 hit its strongest rate of contraction since November 2001, down from 48.6 in August (Please see the end of this post for some information about countries included and the JP Morgan methodology).


According to the JP Morgan report the retrenchment of the manufacturing sector mainly reflected marked deteriorations in the trends for production, new orders and employment. The declines in output and new work received were the second most severe in the survey history, while staffing levels fell at the fastest pace for over six-and-a-half years. The Global Manufacturing Output Index registered 42.7 in September, well below the 48.5 posted for August.

The sharpest decline in production was recorded for Spain, followed by the US, Japan and then the UK. Although the Eurozone Output Index sank to its second-lowest reading in the survey history, it was above the global average for the first time in four months. Within the euro area, France and Spain saw output fall at survey record rates, while in Italy and Ireland the contractions were the second and third most marked in their respective series. Germany, which until recently was the main growth engine of the Eurozone, saw production fall for the second month running and to the greatest extent for six years. Manufacturing activity in Japan fell to the lowest in over 6- years with the Nomura/JMMA Japan Purchasing Managers Index declining to a seasonally adjusted 44.3 in September from 46.9 in August.

At 40.8 in September, the Global Manufacturing New Orders Index posted a reading well below the neutral 50.0 mark. JP Morgan noted that the trends in new work received were especially weak in Spain, the UK, France and the US, with the all bar the latter seeing new orders fall at a series record pace (for the US it was the strongest drop since January 2001). The downturn of the sector led to further job losses in September, with the rate of reduction in employment the fastest since February 2002. Conditions in the Spanish, the UK and the US manufacturing labour markets were especially weak.

Russian manufacturing shrank for a second month in September, and in so doing registered its first back-to-back contraction since November 1998, as companies cut jobs and growth in new orders slowed, according to the latest VTB Bank Europe Purchasing Managers Report. The PMI came in at a seasonally adjusted 49.8, compared with 49.4 in August. The August reading was the lowest figure in three and a half years, according to the bank statement. On such indexes a figure above 50 indicates growth while one below 50 indicates a contraction.

Manufacturing in China contracted for a second month in August, underscoring the risk of a slump in the world's fourth-biggest economy. The Purchasing Managers' Index was a seasonally adjusted 48.4, unchanged from July, the China Federation of Logistics and Purchasing said today in an e-mailed statement.




Brazil's industrial output fell a seasonally-adjusted 1.3 percent in August, the largest monthly drop this year, bolstering expectations the central bank will ease monetary tightening in response to slowing economic growth. On an annual basis, output rose 2 percent, the slowest pace since March, according to data from the national statistics agency in Rio de Janeiro.

And the situation seems to have deteriorated further in September, since the headline seasonally adjusted Banco Real Purchasing Managers’ Index (PMI) registered a 25-month low of 50.4, down from 51.1 in August.

So basically this is where we get to learn what a global credit crunch means in terms of output and economic growth.

India's Industrial Output Weakens Too

India's industrial output growth bounced back again in July (the last month for which we have official data), reaching a five-month year on year expansion rate high of 7.1%. This follows a noted slowdown where output only rose by 5.4 percent gain in June, and 4.1% in May, according to data from the Central Statistical Organisation.


But if we come to look at the manufacturing PMI we will see that India's manufacturing output has also slowed somewhat, and expanded at its slowest pace in 14 months in September according to the ABN AMRO Bank purchasing managers' index. The PMI reading - which is based on a survey of 500 companies operating in India - fell to a seasonally adjusted 57.3 in September from 57.9 in August. This reading was the lowest since July 2007. Still 57.3 still suggests Indian industry continues to grow quite vigoursly, although the report did highlight the fact that the drop in the index was mainly the result of a decline in growth of new orders, and implied a deterioration in demand conditions, both locally as well as in export markets.


Current Account and Trade Deficit

The Rupee has also been dropping in reaction to India's deteriorating current account situation. The current account deficit rocketed to $10.7 billion in the three months from April to June, up from a $1.04 billion gap in the previous quarter,according to data from the Reserve Bank of India last week.

India's trade deficit almost doubled to a record in August as a surge in crude oil prices increased the import bill and overseas sales of goods slowed. The trade deficit widened to $13.9 billion from $7.2 billion a year earlier, according to data from the Ministry of Commerce and Industry. Imports grew 51 percent, the fastest gain in seven months, to $29.9 billion, while exports expanded 27 percent to $16 billion.

A near doubling of oil prices has boosted import costs, since India relies on overseas purchases for three-quarters of its energy needs. India paid an average $8 billion a month this year for oil imports, up from $5.5 billion in 2007, as crude oil costs surged to a record $147 a barrel on July 11. In India's case the 35 percent drop in oil prices we have seen since July has been partially offset by the decline in the rupee to a five-year low.

India's oil imports in August rose 77 percent to $10.9 billion as refiners paid more for crude oil purchased overseas. Non-oil imports gained 40 percent to $18.9 billion. Imports in the five months ended August 31 rose 38 percent to $130.3 billion from $94.6 billion a year ago. That took the trade deficit to $49.2 billion, compared with $34.5 billion in the same period a year earlier. Overseas sales of Indian goods in the five months to August 31 grew 35 percent to $81.2 billion, compared with $60.1 billion, the statement said.

India and Brazil Critical Weathervanes

What I have been arguing in this post is not that everything about India's economy is perfect - far from it, but neither is it the "perfect storm" disaster which current knee jerk reactions among international investors would seem to suggest. The problems which are hitting the Indian economy at the moment, from the rapid rise in inflation to the sudden withdrawal of sentiment have a common origin: the dynamics of the global economy, and it is to these we must now look if we are to be able to sort the wood from the trees about what happens next. Basically, when the dust settles, I think it will be apparent that there are few economies left sufficiently well standing (not Russia certainly, and probably not China, given the export dependence on the developed economies) and with sufficient energy to bounce back. Many may be sceptical that Brazil and India are going to lead the coming charge (this recession cannot, after all, last forever), but I ask you, if it isn't Brazil and India, who is it going to be?

JP Morgan Global Manufacturing PMI Methodology


The Global Report on Manufacturing is compiled by Markit Economics based on the results of surveys covering over 7,500 purchasing executives in 26 countries. Together these countries account for an estimated 83% of global manufacturing output. Questions are asked about real events and are not opinion based. Data are presented in the form of diffusion indices, where an index reading above 50.0 indicates an increase in the variable since the previous month and below 50.0 a decrease.

The countries included are listed below by size of global GDP share, and the figures in brackets are the % og global GDP in each case (World Bank Data).

United States (30.5), Eurozone (18.7), Japan (13.9), Germany (5.6), China (4.9),United Kingdom (4.5), France (4.0), Italy (3.2), Spain(1.9), Brazil (1.9),India (1.7), Australia (1.3), Netherlands (1.1), Russia (0.9), Switzerland (0.7), Turkey (0.7), Austria (0.6), Poland (0.5), Denmark (0.5), South Africa (0.4), Greece (0.4), Israel (0.3), Ireland (0.3), Singapore (0.3), Czech Republic (0.2), New Zealand (0.2), Hungary 0.2.

Disclosure Statement: Edward Hugh is a macroeconomist who maintains a premier set of blogs at Global Economy Matters and is a featured analyst at Emerginvest. Edward Hugh provides non-partisan information about world stock markets, and does not have any holdings in foreign equities. The information stated above should not be construed as investment advice, and Edward Hugh is not liable for any actions taken on said materials.

Indian Inflation Doesn't Budge While Forex Reserves Rise and the Rupee Falls

India's inflation held steady in the week to September 13, rising 12.14 percent from a year earlier, thus maintaining the same pace as in the previous week. The rate has now been trending slightly down from the recent peak of 12.63 percent hit on the 9 August. If this trend continues it should give the central bank the necessary room to hold borrowing costs unchanged and thus avoid placing funding pressures on a banking system which is struggling in the wake of the most recent bout of financial turmoil in the United States.

India's financial system is evidently showing signs of strain as the impact of both local policy tightening and the global credit crunch steadily take hold. The rate at which Indian banks lend to each other climbed to an 18-month high of 15.125 percent on Sept. 19, following the failure of Lehman Brothers Holdings and the U.S. government takeover of American International Group. As a result the Indian finance ministry responded by allowing companies building roads, ports, utilities and other infrastructure projects to borrow more overseas - thus giving them access to cheaper funds - while the central bank announced measures to boost cash in India's financial system.

Indian banks have borrowed an average 642.8 billion rupees from the central bank in the last two weeks, more than five times the average 113 billion rupees in the previous fortnight, further indicating a shortage of funds in the banking system.

Foreign Exchange Reserves Rise Slightly

India’s foreign-exchange reserves rose by the most in five months in the week ended September 19, according to the latest data from the Reserve Bank of India. The rise has surprised many observers, but it should be borne in mind that it coincided with the rise in the dollar against a number of other currencies (and in particular the euro, which the RBI also holds in reserves) on the back of the euphoria about the possible bailout of the US financial system.

Total foreign-exchange reserves rose by $2.51 billion to $292 billion in the week ended Sept 19, while foreign-currency assets - which form the lions share of the reserves -climbed $2.5 billion to $282.8 billion during the week. As we can see from the chart (below) the value of foreign exchange reserves has stabilised since mid-August, so the rot, it would seem, has definitely stopped. I think it is significant that we saw a positive initial response across the key emerging markets to the proposed US bailout, and while we are now seeing considerable volatility as people become nervous about whether it will, finally, arrive.I think when the package is introduced the key emerging market economies will be the principal beneficiaries, as the so called "risk appetite" will bounce back, especially given that the aftermath of the package will be a lower growth period in the OECD economies as the cost of the bailout has to be assimilated.




Even given the recent decline, it is important to bear in mind that India's foreign-exchange reserves, including overseas currencies, gold and special drawing rights with the International Monetary Fund, have increased $56.1 billion in the past year.

Money Supply Continues To Grow

Meanwhile, money supply in India grew year on year by 21 % in the two weeks ended Sept. 12, same rate as in the previous fortnight, according to data from the RBI. M3 - which largely consists of currency in public circulation, bank deposits and money invested in other saving plans, stood at Rs 42,26,143 crore as on September 12.

M3 has been rising at an average rate of 21% since the current fiscal year began on April 1, and has been consistently above the central bank’s target of 16.5% to 17% for the fiscal year ending March. At the same time, total bank loans rose by Rs 32,914 crore in the two weeks ended Sept 12, the biggest fortnightly increase since March. Outstanding bank credit was up by 26.1% year on year and reached Rs 24, 91,248 crore. Food credit was up by Rs 847 crore to Rs 45,190 crore, while non-food credit increased by Rs 32,067 crore to Rs24,46,058 crore. Total bank deposits rose by 22.5%, or Rs 6, 25,282 crore, in the same period to Rs reach 34, 05,377 crore.


The Rupee Weakens Again


The rupee has declined almost 17 percent so far this year and is the second-worst performer among the ten most-active Asian currencies excluding the yen. This week it declined for the seventh consecutive week, the longest run in more than 2 1/2 years. The rupee was down 5.6 percent in September, and is thus headed for its worst month since the Asian financial crisis in 1997.

Foreign investors were net sellers of Indian stocks for a fifth straight month in September, and have offloaded $9 billion so far this year, according to data from the Securities & Exchange Board of India. They bought a record $17.2 billion in stocks last year. Indian stocks fell, with the benchmark posting its biggest weekly drop in six months, after talks on a U.S. credit market rescue plan stalled and Washington Mutual Inc. became the biggest bank failure in American history.



The Bombay Stock Exchange's Sensitive Index, or Sensex, fell 445, or 3.3 percent, to 13,102.18. The index had its biggest weekly drop since the week ended March 7. The S&P CNX Nifty Index on the National Stock Exchange slid 125.30, or 3.1 percent, to 3,985.25. The BSE 200 Index declined 3.2 percent to 1,590.58. Nifty futures for October delivery fell 3.9 percent to 3,995.

Standard & Poor's 500 Index futures slid 1.7 percent when negotiations on a $700 billion bailout plan for U.S. credit markets were thrown into doubt by a group of House Republicans who said the plan drawn up by Treasury Secretary Henry Paulson wouldn't work.

The decline in Indian stocks is more a reflection of global sentiment towards emerging market stocks and bonds than it is an indicator of any specific local issue. The MSCI Emerging Markets Index of stocks has been falling since last May - as can be seen in the chart below - and dropped 1.74% percent on Friday to 823.694, its lowest level since Sept. 15. The index is now down 13.6% so far this month, and 33.87% so far this year. But if you look carefully you can see that it peaked up again after 20th September, as speculation increased that there would be a major bailout of the US banking and insurance sector. This bounce back unwound towards the end of last week, as uncertainty grew about the arrival of the package.


A similar picture can be seen of the JPMorgan EMBI+ emerging bonds index (see below), which has been down significantly since the end of August. Since the US package seems now about to be approved for the US congress, as a result we should see sentiment improve significantly, and India may well be one of the principal beneficiaries of this change in sentiment. The coming weeks should clear all this up quite quickly.

Inflation Holds Steady Again, Forex Reserves Up Slightly

India's inflation held steady at the start of September, making it more likely that the Indian central bank will adopt a wait and see approach before adding to its three interest-rate increases since June. Wholesale prices were up an annual 12.14 percent in the week to Sept. 6 according to the commerce ministry in New Delhi. This follows a 12.1 percent rise in the previous week.



The inflation news follows a very turbulent week in the financial system, and the Reserve Bank of India announced on Sept. 16 a battery of measures to boost cash in India's financial system and sooth concern that the global credit crisis will worsen and have a negative impact on the Indian economy. the central bank said it would sell U.S. dollars and increase interest rates on some foreign-currency deposits to bolster the rupee, which fell the most in a decade during the week. Banks can now get more funds through an additional daily repurchase auction and via a temporary reclassification of eligibility to access funds through the repurchase auction.


Foreign Exchange Reserves Rise Slightly

India's foreign reserves jumped by 650 million to $ 289.461 billion for the week ended September 12 from $ 288.811 billion in the previous week. However it is not clear at this point which way reserves will now move. The global financial markets seem to be in a state of shock following the announcement of the proposed rescue plan for US banks, since few seem to really have any sort of clear idea of what the actual implications are likely to be.




Emerging-market stocks, bonds and currencies gained, extending last Friday's record rally this morning. The MSCI Emerging Markets Index of stocks was up 1.6 percent at 10:10 p.m. in New York, following a 10 percent gain on Sept. 19. The extra yield investors demand to own developing- nation debt instead of U.S. Treasuries shrank 11 basis points to 3.44 percentage points after narrowing 64 basis points on Sept. 19, according to JPMorgan Chase & Co. But US stocks are off again this afternoon, and it isn't really clear which way all this is now going to move.

The Rupee

On the other hand the rupee headed for its biggest two-day advance in a decade on optimism investors will return to emerging markets. The rupee rose 0.8 percent to 45.4525 per dollar at today's 5 p.m. close in Mumbai, adding to the 1.4 percent gain on last Friday. This constitutes a 2.23 percent advance since Sept. 18 and is the biggest two-day gain since January 1998. Eleven of the 15 most-active Asian currencies strengthened today.




The optimism reflected in this most recent rise is in part based on an assesment that the rupee had been declining largely on concerns that the credit-market turmoil in the U.S. would prompt overseas funds to cut holdings of emerging-market assets. The Indian currency had previously been Asia's second-worst performer in 2008, second only to South Korea's won, and had accumulated a 15.4 percent loss.

Indian Industrial Production Bounces Back As Inflation Continues To Ease

India's industrial output growth bounced back again in July, reaching a five-month high of 7.1% year on year growth. This follows a 5.4 percent gain in June, and 4.1% in May, according to data out today from the Central Statistical Organisation. The result is not entirely unexpected if we look at the very healthy year on year increase in exports registered in July (31.2% year on year), on the back of a much weaker rupee. The important thing now is to be inflation back under tight control as agricultural and crude oil prices drop back.




Indian manufacturing, which accounts for about 80 percent of production, gained 7.5 percent in July from 6.1 percent in June, today's report showed. Electricity output rose 4.5 percent in July from 2.6 percent, mining grew 5 percent and consumer-goods production increased 7.3 percent. Capital goods production rose 21.9 percent in the month, compared with 12.3 percent in June. This suggests that strong underlying investment activity is ongoing.

Inflation Eases Back Again Slightly

Indian wholesale prices rose 12.1 percent in the week to Aug. 30 from a year earlier, making for the third consecutive week in which inflation has nudged down slightly. Prices were up by 12.34% the week earlier, according to the latest data from the commerce ministry.




Still, wholesale prices are still rising at more than double the central bank's targeted 5 percent pace, and have been doing so  since June. So we should expect no easing of the central bank inflation vigilance at this point.

Declining oil and commodity prices are obviously helping cool inflation across Asia and easing pressure on the region's central banks to keep increasing interest rates. Consumer prices in China rose 4.9 percent in August from a year earlier, the smallest gain since June 2007.  Crude has fallen about 30 percent from a record $147.27 a barrel on July 11 as high prices and slowing global economic growth reduced demand for fuels.

Prices of rice, corn, onions, potatoes, spices and edible oils were all down in the week to Aug. 30. Manufactured products price inflation, which has a 64 percent weight in the inflation basket, was up 11.07 percent on the week, down from the 11.28 percent gain in the previous week.

India's Foreign Exchange Reserves Continue To Fall


India's foreign exchange reserves fell again in the week ended 5 September, to $288.8 billion dollars, down $6.5 billion on the previous week, and down $27.36 billion from the May 23 high of $316.2 billion.





As Does The Rupee


The rupee declined gain this week, making it the fifth consecutive week of decline, and the longest losing stretch since May, as global funds shunned emerging-market assets on concern the economic downturn is spreading from the U.S. to Europe and Japan. This is not an entirely logical result in the case of India, as I have been trying to argue. But for the moment, and given the current investor mindset, this is how things are.

The rupee fell to its lowest level in almost two years, and the data show that overseas investors sold more Indian shares than they bought on five of the seven trading days in September. Ironically though the underlying fundamentals - as we are seeing in the industrial output and inflation data may be starting to improve. Falling oil prices will help domestic deflation, and a slightly weaker rupee, and stronger dollar, may well benefit exports.


The rupee was down 2.35 percent on the week to 45.71 to the dollar at the 5 p.m. close in Mumbai on Friday, its lowest level since Oct. 10, 2007.



If we look at the above chart, the deterioration in the value of the rupee against the dollar since the end of July is evident, and this forms part of a global trend. Since India is not a major oil or commodities producer, and since as I say underlying fundamentals (leaving aside the tricky fiscal deficit issue) are more likely to improve than deteriorate, it is not clear what the real justification for this - other than knee-jerking - actually is.

Foreign investors were net sellers of Indian stocks for a fifth straight month in August, and have sold a net $7.6 billion so far this year, according to data from the Securities and Exchange Board of India. They bought a record $19.5 billion in stocks and bonds last year, helping the rupee rally 12.2 percent, the biggest annual advance in more than three decades. The currency has since erased all of those gains.

India's Inflation Holds Steady, Exports and the Trade Deficit Rise, While The Rupee and FX Reserves Fall

India's inflation remained well above the central bank's comfort level for the sixth straight month towards the end of August, increasing the likelihood that incoming Governor Duvvuri Subbarao will continue to raise interest rates. Wholesale prices were up by an annual 12.34 percent in the week ended August 23, according to the latest data from the Indian commerce ministry said in New Delhi. That compared with a 12.4 percent gain in the previous week.



Subbarao, whose three-year term at the Reserve Bank of India starts this weekend is under some pressure to show that he is independent and no less concerned about inflation than his predecessor, and is quoted as saying that the "obvious" answer to surging prices is tighter monetary policy. Outgoing Governor Yaga Venugopal Reddy increased the central bank's benchmark rate three times between June and the end of August, giving a higher priority in the short term to the battle against inflation rather than to economic growth. In the mid-term these both amount to the same thing, since unless India gets inflation under control a whole battery of other macro economic indicators will become misaligned, and then it will be near impossible for India to realise its full growth potential, which I personally consider to be a couple of percentage points higher then consensus opinion would have it.


The Reserve Bank on July 29 raised its benchmark interest rate by a half point to a seven-year high of 9 percent. The central bank's next policy announcement is due Oct. 24.

Elevated energy, commodity and food prices remain the main concern, and these forced the central bank in July to raise its inflation forecast for the year to March 31 2009 to 7 percent from a previous target of between 5 percent and 5.5 percent. At the same time India's economy grew at "only" 7.9 percent in the three months to June 30, the weakest since the last quarter of 2004, according to data from the government statistics office last week.



Consumer-price inflation for agricultural and rural workers accelerated to 9.41 percent in July, compared with 8.77 percent for farm workers and 8.75 percent for rural workers in June, according to government data. India releases separate indexes for consumer prices paid by industrial, agricultural and rural workers, and as we can see, these come out with a significant time lag, hence the most widely tracked measure of inflation in the Indian context is the wholesale-price index.

But there are indications already that the tide may be turning. Prices of fruits, spices, sugar, tea and eggs continued to rise in the week to August 23, but prices of vegetables, pulses, edible oil and cereals fell. Manufactured price inflation on the other hand continued to move up, rising 11.28 percent, compared with 11.02 percent in the previous week.

A big part of the issue is what happens to agricultural output this year. The June-September monsoon season, which accounts for four-fifths of India's annual rainfall, has been more or less "normal" this year, according to data up to the 3 September supplied by the India Meteorological Department (the chart really is worth a look).

Most sources seem mildly optimistic on the agriculture front. India, which is the world's biggest producer of rice after China, partly lifted a six-month old ban on the export of some premium quality grain as the country looks set to harvest a bumper crop for a second year running. Overseas sales of Pusa-1121, a strain of rice grown in north Indian states, will be permitted as of October 15, the trade ministry said during the week. Global rice prices now have fallen 25 percent from their April high as Thailand and Vietnam, the leading global suppliers, lifted export forecasts after farmers increased plantings. Vijay Setia, president of the New Delhi-based All India Rice Exporters Association estimates that India may export most of the 1.4 million ton output of Pusa-1121 variety forecast for this year. Sowing of paddy in India is up by 5 percent to 34.5 million hectares as of August 28, according to the Indian ministry of agriculture. Setia estimates that output may be some 10% above last year's record of 96.43 million tons, and Mangala Rai, director general of the Indian Council of Agricultural Research, holds a similar view.

Farmers in India, which is the world's second-biggest wheat producer, may also increase planting starting October because of favourable rainfall, possibly helping India garner a record harvest for a second year. Wheat, which is the country's biggest winter food grain, is planted from October through December. Harvesting starts in March and continues through April. Again the agriculture ministry estimates that India harvested a record 78.4 million metric tons of wheat in the year ended June 30, up 3.4 percent from the year to June 2007.

A bigger harvest will obviously help reduce the problems of food shortages that have stoked inflation and lead India to import 1.79 million tons of wheat since July 2007 to build up stockpiles. These imports from India are among the factors which helped fuel last year's 77 percent gain in wheat prices on the Chicago Board of Trade index.


Energy prices also seem to be easing, and rapidly. Oil prices fell to their lowest level in five months last Friday as investors worried that an economic slowdown could chip away at the demand for energy. Light, sweet crude for October delivery closed down $1.66 to $106.23, capping off a week of declines that totaled $9.23. It was the lowest settlement price since April 3, when crude settled at $103.83 a barrel.Oil prices have fallen more than $40 from the record high of $147.27 a barrel on July 11, two months ago, as a struggling global economy has cut into demand for energy. The US is leading the way in the decline in demand for oil, and the US Energy Information Administration reported Thursday that imports of crude in August were 200,000 barrels a day below the same four-week period last year. This pattern is repeated to some degree or another in economy after economy across the globe.

Now all this will evidently have a floor, but where exactly does that lie? My own view is that the decline will continue, but that we may see a floor around $80, since at some point the inflation situation will ease back, and growth will rebound, and then of course the price will head up again.

My feeling is also that we could then see quite a quick turnaround in inflation in emerging economies like India (from 13% to say 7%) and this will then mean the negative lose lose dynamic of rising inflation, rising trade deficits, rising interest rates, falling currencies and falling growth can transform itself into the win-win dynamic of falling inflation, falling trade deficits, slightly lower (but still very yield differential attractive) interest rates, rising currencies and rising growth.

The interesting question is when will we hit the inflection point? Well, if we look at the NYMEX chart below, we will see that oil prices really started to take off in October 2007, and that at current rates of decline in oil prices the two curves should cross (ie 2008 prices should be below 2007 ones) sometime between October and November. Now this will be quite an important event in the emerging market economies, since given the weight which has been attached to energy and food rises in the total inflation picture, once these (for so called base effect reasons) start to clock negative readings, headline inflation should start to sink back.



Within six months of this cross-over we should see the Indian economy really start to pick up speed again, and in particular we should see a strong rebound in industrial output. India, remember, is still growing at a 7.5% annual rate, but this could easily change as the Indian economy starts to "break sweat" and heads upwards again towards 10% (and even beyond). Depending on the future evolution in energy prices I see trend growth in India in the 2010 - 2015 window of between 10% and 12%.



Foreign Exchange Reserves Fall Again

India's foreign exchange reserves dropped back again in the week to 29 August, falling by $1.98 billion (Rs8,791 crore) to $295.3 billion, according to Reserve Bank of India data. Foreign currency assets declined $932 million to $286.11 billion during the week, while gold reserves dropped by $1.04 billion to $8.7 billion,and reserves with the International Monetary Fund (IMF) decreased $2 million to $496 million. India’s special drawing rights with IMF were unchanged at $4 million.



There are various explanations for this continuing fall. One of them is the purchase of dollars by India's oil importers, another is intervention by the Reserve Bank of India (to stop the weakening in the rupee, which to some extent is welcome as it helps exporters, but beyond a certain point becomes most damaging as it only adds more wood to the domestic inflation bonfire) and a third is the selling of Indian equities by overseas investment funds.

All three of these could reverse as oil prices drop and inflation comes under control, since importers will need less dollars, the RBI will not need to intervene since the rupee will be rising, and both of these factors will make India's stock markets once more an attractive proposition for the overseas funds. This is what I mean by "win-win".


Rupee

In the meantime, the rupee slumped back for a fourth successive week on speculation economic slowdown in the U.S. and Europe will prompt global funds to shun emerging-market assets. The rupee dropped to a 21-month low versus the dollar, sliding in tandem with currencies across Asia, as regional stocks tumbled. In this context I very much agree with the view expressed in a recent research note by Kotak Institutional Equities:

"The current USD rally was prompted by technical factors and fears that the US slowdown would lower growth globally sparking flight to dollar as a perceived safe heaven. We feel this argument is overstretched. 1QCY08 COEFER data reveals continued slow movement away from USD and into Euro in reserves. Share of EUR in reserves has increased to 27% in 2008 from 18% in 2000, while that of the USD has dropped to 63% from 71%. We consider it a paradox that the USD continues to be considered a safe heaven despite US credit markets being the epicenter of the current global economic turmoil.......... In real terms, returns on USD assets continue to be negative, making the current USD rally unsustainable"

Basically, the move into the US and Japan as safe havens, seems to be more of a "herd like" knee-jerk response, especially when looked at over a weekend where the US government may well move in and temporarily take over FannyMae and FreddyMac, and as Japan seems to be sliding steadily downwards into its next recession. I also agree with Kotak that the weakening in the rupee is now starting to look decidedly overdone and may well move into reverse gear in the not too distant future.

But this possibility, for now, lies out in the future, and in the present the rupee fell a further 1.7 percent against the dollar this week reaching 44.66 per dollar as of the 5 p.m. close in Mumbai: This was the lowest level since Dec. 20, 2006, and the rupee is now down 11.8 percent against the dollar so far this year as equity sales by global investors exceeded their purchases by $7.1 billion.





Heavy demand for dollars from corporates, and especially oil companies, coupled with anticipated losses in the local equity market had a significant effect on market sentiment. The currency fell to a low of 44.75 at one point — its lowest in over 20 months, before the central bank intervened to halt the fall.

If the central bank had not stepped in, then the rupee could even have breached the psychologically important 45 threshold already on Friday. In the view of some market participants, sentiment for the rupee is extremely bearish at the moment, over concerns over capital outflows, the falling stock market and a rising fiscal deficit. The latter of these is important, but I do think the first two are being overdone, and reflect a rather old fashioned mindset, since as Kotak point out, it a paradox that the USD continues to be considered a safe heaven despite US credit markets being the epicenter of the current global economic turmoil.


External Borrowing

India’s external debt went up sharply - by over $50 billion, according to Finance Ministry data - during the financial year ended March 2008, the highest year-on-year increase ever. A fall in the value of the dollar against the Indian rupee and other international currencies, along with increased overseas borrowings by companies seem to be the main reasons for the increase. External debt, both government and non-government, stood at $221.2 billion as on March 2008, representing an increase of over 30 per cent in one year.

External commercial borrowings (ECB), used by corporates to borrow money from abroad at a cheaper interest rate, were up more than 40 per cent, and reached $70.6 billion in 2007-08, as compared to $48.52 billion a year earlier. The share of such overseas borrowings in the total debt has risen to nearly 32 per cent now from under 24 per cent two years back.



Two concerns dominate the views of foreign inflows through ECBs. First, the influx of borrowings from abroad will increase the domestic money supply that has potential to accelerate the inflation rate.Second, flow of money to sectors like real estate — which is classified as ‘sensitive’ by the government — was feared to cause price inflation. The weakening of the US dollar against other currencies accounted for 20 per cent of the increment in India’s external debt, said the report titled “India’s External Debt- A status report 2007-08”. As nearly 57 per cent of India’s debt is denominated in US dollar, any decrease in the value of the US dollar against the Indian rupee and other international currencies means that stock of external debt as measured in rupees increases. In 2007-08, Indian rupee appreciated against US dollar by as much as 13 per cent, as per data available with Reserve Bank of India.

Despite the increase, the ratio of government debt to total debt has declined by 2.8 percentage points to 25.6 per cent as on March 2008, reflecting the higher share of private borrowings. Key external debt indictors like ratio of total external debt to GDP, ratio of short-term debt to foreign exchange reserves and ratio of short-term debt to total debt have shown an increase in the financial year 2007-08. For example, ratio of external debt to GDP is now at 18.8, an increase of 1 percentage point and ratio of short-term debt to total debt stood at 20 per cent — an increase of 6 percentage points in one-year.

Because of larger borrowing by corporates, government’s debt as a proportion of total external debt declined from 28.4% to 25.6%. As a percentage of gross domestic product (GDP), sovereign debt dropped from 5.3% to 4.8%.

The ratio of short-term debt to foreign exchange reserves stood at 14.3% at the end of the year against 13.2% at the end of March 2007. The ratio of short-term debt to total external debt was 20% at the end of March this year against 15.5% in the year before.


Trade Deficit Rises In July


India’s trade deficit widened to $10.79 billion in July, up 83 per cent from $5.87 billion in the year-ago month, as the growth in imports far outstripped exports. But perhaps the big news here is the growth in exports, which in July were up a very healthy 31.2 per cent year on year to reach $16.34 billion. Imports registered an even sharper annual rise of 48 per cent to $27.14 billion, mainly due, of course, to the increase in the value of crude oil imports, the price of which touched an all-time high in July. Oil imports expanded 70 per cent and stood at $9.5 billion as against $5.6 billion in July 2007. Non-oil imports in July stood at $17.66 billion, which is still an increase of 38.7 per cent over the $12.73 billion registered the year before.

Of course the oil factor isn't entirely a one way street, and high crude oil prices also mean that domestic refiners like Reliance Industries sell their products at a higher rate in overseas markets, adding to the export increase, and, with a 40 per cent increase in steel prices, the value of engineering goods’ exports also increased accordingly.