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Saturday, September 06, 2008

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".


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.

Monday, September 01, 2008

Indian Inflation Eases Back Slightly In Mid August

India's inflation held near a 16- year high as floods in half the country damaged crops and disrupted food supplies. Wholesale prices rose 12.40 percent in the week to Aug. 16, after increasing 12.63 percent in the previous week, the commerce ministry said in New Delhi today.

The annual June-September monsoon season, which accounts for four-fifths of India's annual rainfall, has this year caused flash floods which have already displaced 12.6 million people and killed 18,859 animals, according to the national disaster management office.

Bonds rose, pushing yields to the lowest levels in almost two months. The yield on the benchmark 8.24 percent note due April 2018 slid 11 basis points to 8.77 percent as of 5:30 p.m. in Mumbai, the lowest level since July 1, according to the central bank's trading system.

The Reserve Bank last month raised its benchmark interest rate by a half point to a seven-year high of 9 percent. The reserve requirement for commercial lenders was also lifted to 9 percent from 8.75 percent.

Prices of pulses, fruits, spices, sugar and textiles rose in the week to August 16, while prices of vegetables, meat and edible oils declined, today's report showed. Manufactured price inflation rose 11.02 percent, compared with 10.91 percent in the previous week.

India's central bank, having raised interest rates to the highest in seven years, will continue to take steps to curb inflation that's risen beyond ``tolerable levels,'' imperiling economic growth.

``Inflation risks have increased sharply and appear to be persistent,'' the Reserve Bank of India said in its report for the year ending June. ``An overriding priority for monetary policy would be to eschew any further intensification of inflationary pressures.''

The Reserve Bank raised borrowing costs three times in as many months to curb inflation that's more than double its target. Rising fuel and food prices may further depress Asia's third-largest economy after growth slowed to the weakest since 2004, a report today showed.

Foreign Exchange Reserves Edge Up Slighly

During the week ended August 22, forex reserves rose by $1.08 billion to $297.29 billion. Foreign exchange reserves rose above the $300-billion mark in February this year and touched an all-time high of $316.17 billion in the week ended May 23. However, in week ending 15 August they broke the threshold in a dwonward direction.

Reserves have now declined in six of the last seven weeks.

The Rupee Continues Its Decline Against USD

India's rupee declined in August, maily on speculation oil importers exchanged the currency for dollars to pay end of month bills. The currency closed at 43.935 against the dollar as of the 5 p.m. in Mumbai on Friday - its lowest level in more than 17 months - on concern slowing economic growth and inflation near a 16-year high will prompt overseas investors to offload more local shares. That puts the rupee down 3.1% on the month.

Overseas investors has sold $7.2 billion more local shares than they bought this year as the benchmark stock index slumped 28 percent. They were net sellers of Indian stocks on all but six of the 17 trading days up to Aug. 27.

The National Stock Exchange of India Ltd. last week started trading in currency futures, the country's first, to help investors hedge their foreign-exchange risk. The total traded volume on the first day was $65.8 million.