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Friday, August 22, 2008

India's Inflation Up Again At The Start Of August

India’s inflation rate shot up to its highest level in more than 16 years this month, increasing the chances of the fourth rise in interest rates in Asia’s third-largest economy since June. Wholesale prices rose 12.63 percent in the week to Aug. 9, after increasing 12.44 percent in the previous week, according to data from the commerce ministry in New Delhi today.




And inflation may climb even higher following a decision last week by Prime Minister Manmohan Singh's cabinet to approve an average 21 percent pay rise for 5 million civil servants, ahead of elections due by May.



Indian stocks declined after the news was released on concern faster inflation and higher interest rates will crimp consumer spending and slow the pace of economic growth even further. Bonds also declined with the yield on the benchmark 8.24 percent note due April 28 up 7 basis points to 9.21 percent.

India's central bank last month raised its inflation forecast for the year to March 31 to 7 percent from a previous target of between 5 percent and 5.5 percent. The bank's next policy announcement is due Oct. 24.

Inflation in India in the week to August 9 accelerated because of a rise in the cost of pulses, cement, vegetables, sugar and textiles. Manufactured price inflation rose 10.91 percent, compared with 10.75 percent in the previous week, today's report showed.

Foreign Exchange Reserves Fall Again


There was a further fall in India's foreign exchange reserves in mid August with the level dropping back for the fifth consecutive week to below the USD 300-billion mark. Reserves dropped by USD 3.8 billion to USD 296.21 billion during the week ended August 15 from USD 300.01 billion in the previous week, according to the Reserve Bank of India's latest statistical bulletin.



One item which has emerged in the last week is the extent to which the RBI has been offloading US treasuries. According to US Treasury data Indian institutional holdings of US treasuries dropped $3.3 billion in June following the launch of special market operations by the Reserve Bank of India to extend support to public sector oil company efforts to keep their liqidity afloat in the face of rising crude prices. India’s holdings were down to $11.7 billion in June vs June 2007, the sharpest drop ever on a year-on-year basis. Among Indian institutions that hold US Treasuries are the RBI, the General Insurance Corporation of India, the foreign branches/subsidiaries of domestic banks and domestic mutual funds that are permitted to invest in foreign securities.

A large part of the drop in dollar treasury holdings came from the treasury operations by the RBI and the consequent Special Market Operations (SMOs). SMOs were introduced in June to meet the needs of refinery funding operations. The operations involved purchase of subsidy bonds from the refining companies and advance of dollar to them for meeting crude oil payment obligations.

The SMOs were in part a response to the low earnings which accrued from dollar treasuries. Most of RBI’s holdings of US treasuries are in the form of short-term securities. The yields on dollar treasuries ranged between 1.6 per cent for 30 days and 2.36 per cent for one year. Assuming the cost of sterilisation at around 6 per cent, which is the reverse repo rate, the spread was negative by at least 4 per cent. This negative spread implied that such additions to India's foreign exchange reserves were imposing excessively high on-costs.

Oil bonds were acquired by the RBI at yields which were in the region of 8.75 to 9.5 per cent. Oil bonds are sovereign securities issued by the Indian Government against outstanding payments to the refining companies. Most of the oil bonds purchaes were in the form of long-term securities. By mid August the RBI had purchased about Rs 20,000 crore ($4.5 billion) of oil bonds from the refineries.

The RBI has also moved an unknown portion of its holdings out of USD assets and into other currencies, particularly the euro and the pound sterling, in view of the ongoing dollar depreciation, as well as the low yields on offer.

The other principal cause of the recent downward movement in the reserves has been the sale by foreign institutional investors. Overseas funds sold more equities than they bought on eight of the twelve trading days in August. Such funds have thus sold $7.1 billion more Indian shares this year than they have bought, according to data from the Securities and Exchange Board of India. In 2007 they bought a net $17.2 billion last year, which was a record, and both added to reserve accumulation and helped the rupee complete its best year since at least 1974.

These outflows are to some extent offset by inflows from Non Resident Indians for equity investments. Such investments were running at $2.2 billion in the first quarter of this financial year (ie April to June) and are treated as part of foreign direct investments. However the FDI component in India's BoP is also showing signs of slowing down, with NRI investment flows for share acquisition in June - at around $398 million - being at their lowest level in some time.

The Rupee

The rupee fell for the second consecutive week last week as declines in the stock markets spurred fund outflows. The currency fell to its lowest in 17 months as the rebound in crude oil prices from a 15-week low spurred demand for the dollars needed to pay for imports, and the high level of inflation encouraged overseas funds to sell stocks. Despite the fact that the Bombay Stock Exchange's Sensitive Index, or Sensex, rose 157.76, or 1.1 percent, to 14,401.49, on Friday - the most since Aug. 11 - the index in fact posted its second weekly decline, falling 2.2 percent. The rupee was down 0.9 percent on the week to 43.425 per dollar at the 5 p.m. close in Mumbai. On August 20 alone overseas investors sold a net 2.85 billion rupees ($70.8 million) of Indian stocks.

1 comment:

albertjames said...

India's abundant labor, trained technical manpower and English-speaking population are seen as valuable assets in the global economy, particularly in the services, research and manufacturing sectors.
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albertjames
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