India's Growth Rate Slows Further In Q2 2008

In the second quarter of 2008 (the first quarter of the financial year) India’s economy grew at it slowest rate in three years, as the Reserve Bank of India struggles to control record high inflation by applying tight credit conditions. Annual growth slowed to 7.9 per cent in the quarter of 2008 which ended on June 30, significantly lower than the 8.8 per cent rate reported for the January to March quarter.



Growth momentum has obviously been slowing on tighter monetary policy and the adverse global environment. Higher interest rates, slower bank credit growth and higher oil and commodity prices are evidently now having a marked effect on activity levels in the Indian economy. However, in spite of the slowdown, the growth rate of Asia’s third largest economy remains strong, and there are very positive signs of resilience in the face of what is now a global economic slowdown. China’s economic growth also slowed in the second quarter dropping to a 10.1 per cent year on year rate, from 10.6 per cent in the first quarter.

Despite this slowing growth the Reserve Bank of India is very likely to maintain its tight policy stance until it succeeds in bringing inflation down significantly from the current double digits level. Inflation fell back slightly in mid-August but it may well tick up again before the year is out.

Growth in the services sector, which includes banking, transport and leisure, and the construction sector remained strong at 10 and 11.4 per cent respectively. The manufacturing sector suffered the sharpest fall as it grew only 5.8 per cent compared to 10.9 per cent in the same period in 2007.

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.

India's Inflation Accelerates Again At The Start Of August

India's inflation shot up again at the start of August and hit a 16-year high of 12.44% in the week to Ausust 2, following a 12.01% increase in the previous week, according to data from the Commerce Ministry. Concerns have also been raised that inflation may accelerate further after the government approved sizeable wage increases (in the region of 21%) for civil servants.



The Indian cabinet yesterday approved an average 21 per cent pay rise for 5m federal employees and military personnel. This is effectively the first revision of government salary scales for 12 years. P. Chidambaram, finance minister, said on Thursday that the civil servants’ pay rise, to be backdated to January 1 2006, would cost Indian taxpayers $3.6bn (€2.4bn, £1.9bn) this fiscal year, including part of the arrears from 2006. Separately, Indian Railways will have to pay $1.5bn to its employees.

Basically the problem here would seem to be the timing of this decision. The majority of the civil servants in question here are hardly going to be well paid, although many of them may well be doing tasks of questionable value, either economically or socially. However this decision is likely to complicate the inflation battle significantly, and raises the level of concern on the fiscal deficit front.

The real issues here are associated with the burden represented by subsidies for fuel and other necessities, which are now estimated to exceed 5 per cent of gross domestic product. The pay rises, by way of comparison, are estimated to represent a costof 0.4 - 0.5 per cent of GDP. India's Finance Minister Palaniappan Chidambaram has said the salary rise had been factored into the government budget for the current fiscal year and will not affect the budget deficit target of 2.5 per cent of GDP, but the issue is really that the subsidies are effectively not included in this calculation, since they are off balance sheet. Indeed, only yesterday the prime minister’s Economic Advisory Council warned that the government’s fiscal situation “no longer looks stable or sustainable” as a result of the growing subsidy bill.

The Reserve Bank of India last month raised its benchmark 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. Governor Yaga Venugopal Reddy, who is targeting inflation of 7 percent in the year to March, has said he is ready to act again if necessary, and it now seems almost certain that he will need to.


Foreign Exchange Reserves

India's foreign exchange reserves fell by US$ 5.464 billion to US$ 300.010 billion during the week ended August 8 from US$ 305.474 billion during the previous week. The country thus registered a fall in its foreign reserves for the fourth consecutive week. One part of the explanation for this weeks rather large drop may well be that the Reserve Bank of India has been selling dollars to keep a cap on the value of the rupee.

So, after some years of buying dollars in the forex markets, the RBI has now started selling dollars. Strong portfolio inflows continue, and the central bank continues to mop up what it perceives to be excess liquidity coming from this quarter. However oil importer demand for dollars has been up sharply in recent weeks forcing the central bank to be net sellers of the dollar. As result, total reserve with the central bank has dipped almost $10 billion since the beginning of this fiscal year in April. Nonethless a 5.5 billion USD drop in one week is quite sharp.






Despite tighter monetary policy from the RBI the supply of credit continues to expand, and grew by 25.8 per cent during the year up to August 1, 2008, compared with 23.3 per cent growth registered a year earlier. Outstanding bank credit stood at Rs 24,27,592 crore on 1 August. Banks have extended credit worth Rs 65,678 crore since April 2008. Advances declined by Rs 1,787 crore in April-July 2007. The central bank has projected a 20 per cent growth for adjusted non-food credit in 2008-09.

Deposit expansion on the other hand has failed to keep pace, and deposits only grew by 20.9 per cent in the year to 1 August 2008 against a 24.4 per cent rise in the same period last year.

On the other hand the drop in foreign exchange reserves does seem to be having an impact on the rate of growth in the money supply (since of course dollar sales mean less rupees going the rounds), and money supply growth has dropped back, for the first time this fiscal year, to within the banks comfort zone of below 20%. As per the latest RBI data, the Y-o-Y growth in money supply slipped to 19.6% as on August 1, from a high of close to 23% a few months ago. The total stock of money in the system amounted to Rs 41,79, 900 crore as on August 1, up Rs 32,479 crore over the previous fortnight’s levels.

Rupee

India's rupee declined on Thursday by the most in three months on speculation global stock losses will spur investors to pare riskier emerging-market assets. A 27 percent drop in India's benchmark stock index has prompted global funds to exit the market as it heads for the first annual loss since 2001. The rupee fell 1 percent to 43.055 per dollar at the 5 p.m. close, the lowest since July 16

India's Industrial Output Still Sluggish In June

India's industrial output growth accelerated slightly in June. Output at factories, utilities and mines rose 5.4 percent from a year earlier after a revised 4.1 percent gain in May, according to data fromthe Central Statistical Organisation.




What this means is thatIndia's industrial production grew 5.2 percent in the quarter ended June 30, almost half the 10.3 percent pace in the same period a year earlier, and this will almost certainly be an important negative for Q2 GDP growth. Factory output growth may well slow further in coming months following interest rate and cash reserve increases from the central bank.

Manufacturing, which accounts for about 80 percent of Indian production, gained 5.9 percent in June, compared with 9.7 percent in June 2007. Electricity output rose 2.6 percent in June from 6.8 percent in a year-ago, mining grew 2.9 percent from 1.5 percent and consumer-goods production increased 10 percent.