April 2008

   7 April 2008
Indian Economy Next Quarter
Inflation, as anticipated, is on the boil at 7% ? global trends and supply limitations make this difficult to reverse.
Govt. swings in with duty cuts and export bans- but this is unlikely to work.
Corporates have tough times ahead ? profitability hit by high input prices and wage pressures.
RBI stand on interest rates vindicated - no rate cuts expected.
Pay Commission burden on fisc less than expected but it fails to win hearts ? it will further feed inflation.
Rupee slides down with high crude prices and FII investment outflows in March ? no calm expected in markets ahead.
India : Kal, aaj aur kal
We got quite tired the last few months warning about inflationary pressures, what is surprising to us is that inflation appears to have surprised the government and financial markets. High energy prices, asset price inflation, and high growth are an unbeatable combination for overall price rise. True, the government tried all possible tricks, and appeared to succeed quite admirably for a while, but that was impossible to sustain for long.

The government can now let the rupee rise, increase interest rates or reduce liquidity, and/or try and directly intervene in the markets by clamping on prices. Given the seriousness of the situation, it will try all possible measures. Of these, the last will be the worst possible solution since firms and consumers get fudged price signals. But this will be most attractive for the centre-left politicians; it is unlikely that either the FM or the PM will be able to hold out.

However the government acts, some outcomes are quite predictable. First expect some reduction in inflation in the next few weeks (inflationary tendencies are typically lower in April), but the spectre of high inflation will not go away throughout this year. Second, expect somewhat lowered growth this year.

Maintaining high growth is going to be the toughest challenge for this government. Agricultural output seems to have taken a big hit with the recent showers across north India, and it will be difficult to sustain high levels of investment with the expected liquidity tightening and upward pressure on interest rates. That is, there is not much the government can do, expect hope that the international environment in crude and commodity prices changes dramatically in the next few weeks.

While forecasts for growth in India are rapidly being revised downwards, drastically towards 7%, we don?t share this pessimism. We maintain our estimate of 8-8.5% growth as we had incorporated high inflation in our growth expectations. That could however change if (i) the weather gods are not benevolent, (ii) the international slowdown accelerates, and (iii) the government over-reacts on either exchange or interest rates. In short, our advice for the government at this point is ? do some tweaking and hope for the best!

Sumita Kale & Laveesh Bhandari
7th April 2008 Indicus Analytics
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Economic Growth

Indicus Forecast 2007-08

GDP 8.2%
Agriculture 2.8%
Manufacturing, Mining & Electricity 8.6%
Services including Construction 9.6%

Month of forecast: March 2008

IIP growth in January slowed to 5.35% with manufacturing activity growing at a 5.87% rate, mining at 1.81% and electricity at 3.29%.
Infrastructure sectors have clocked in 5.5% for the period Apr-Jan, compared to 8.9% for the same period last year.
February growth in infrastructure however was faster at 8.7%, with coal, electricity and cement clocking in higher rates of growth.
Electricity generation grew at 9.57% in February, but that was on a low base of a 3.3 % growth in February 2007, not indicative of a positive trend in performance.
ABN-AMRO purchasing managers index revealed slowest growth in the last eight months for March, reflecting the downward trend in manufacturing growth.
India is all set to become second largest wireless network in the world, beating the USA as it will cross 300 million subscribers in April.
Tele-density stands at 25.31% in February. Rural tele-density has increased from 2 to 8 % over the last year.
Railway freight earnings grew by 13.41% in the period April-February compared to 14.89% last year; freight traffic registered a rise of 8.99 % compared to 9.12% the previous period.
Read: Race to the bottom
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Crude crossed the 100 dollar a barrel mark and stayed around that level throughout March.
WPI provisional data for week ending March 22nd put inflation at 7.0%, with revision to January numbers bringing inflation way past the 4% mark.
Consumer Price Indices for February show rise in CPI (AL) to 6.38%, CPI(UNME) to 5.23%, while CPI(IW) is still low at 5.47%.
CPI UNME item wise inflation shows that cereals have risen by 5.83%, oils and fats by 18.69%, milk and milk products by 10. 48% over the last year.
Pressure has come in not just from agricultural produce but also from iron ore, steel etc. These are following global trends and not easy to suppress domestically.
Current data indications show that while the April inflation will be lower than March levels, in the range of 5.6-5.8%, inflation trend is still on the upside, set to cross 6% in May.
Read: No time for field theories
Read: German March inflation accelerates more than forecast
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Interest Rates
While the Fed continued to cut rates in March, down by 300 basis points now in the last six months. ECB maintains stance of no rate cuts, looking at Eurozone inflation at highest in 16 years.
As anticipated in our last newsletter, in India, the 10 year Gsec yield stayed in the 7.5 to 7.7 range in March but shot past that level by the end of the month as the inflation numbers came in high and the markets realised the message that the RBI had been trying to give since the status quo maintained in January review.
Readers should note that these are uncertain times and inflation will always have a priority over growth in the Indian economy, given the impact on the poorer sections. In the April review, therefore the RBI take will depend on how the data pans out over the following month.
For the month ahead, expect the 10 year benchmark Gsec to have a strong upside bias depending on the inflation data. Yields can cross 8% in the short term.
However, if the RBI maintains a status quo the yields can drop. In short, expect more volatility in Gsec prices as markets adjust.
Read: Bernanke wrote the book on Inflation, Depression.
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Exchange Rates
A month back, the RBI appeared to be fighting to defend the level of 39 rupees to a dollar, the downward swing past 40 should have given it some relief on that front, but a depreciation at this moment is not in the interest of curbing inflation.
Exports grew at 8.94% in rupee terms and 22.9 % in dollar terms for the period April to February, imports grew at 15.42% in rupee terms at 30.21% in dollar terms, raising the trade deficit to $72.47 billion compared to $49.32 billion last year.
The high crude prices are one reason for the rising oil import bill but non-oil imports have also grown at 31.83% in the period April-February.
FII investment outflow in equity markets continued in March taking out $ 2.8 billion since January, though the debt investment is still positive overall at $ 885 million, there was an outflow from here in March.
Expect the rupee to range between 39 and 41 over the next couple of months, with crude oil price and the financial market volatility impacting the actual levels.
Read: Something smells different
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