Market to take cues from global equities

On Monday, 5 September 2011, Indian stocks will react to US employment report for August 2011 due on Friday, 2 September 2011. Economists expect US non-farm payrolls to rise by a paltry 46,000 after a less-than-impressive 117,000 rise in July 2011. The unemployment rate is forecast to remain unchanged at 9.1%. The US market remains closed on Monday, 5 September 2011, for the Labour Day holiday.



Closer home, there are concerns that India's strong Q1 June 2011 GDP growth data could prompt the Reserve Bank of India (RBI) to continue raising interest rates when it undertakes mid-quarter policy review on 16 September 2011 to restrain inflation, which remains well above the central bank's perceived comfort level of 5% to 6%.

The latest data showed that the Indian economy expanded 7.7% in Q1 June 2011 from a year earlier, helped by a robust 10% growth in the services sector. The manufacturing sector grew an annual 7.2% in Q1 June 2011, while farm output rose an annual 3.9%, the data showed. The central bank has raised its main interest rate 11 times since March last year, but annual inflation has remained stubbornly high above RBI's comfort levels.

Recently, RBI said that there is a need to rebalance demand from consumption to investment by stepping up savings in the economy. In order to achieve a 9% growth in Twelfth Five Year Plan (2012-17), the investment rate of 40.5% would be required if incremental capital output ratio (ICOR) remains unchanged from 4.5% during the Eleventh Plan. This requires augmenting saving as well as bringing about technological and institutional improvements to lower ICOR.

In its annual report for 2010-2011 released on 25 August 2011 RBI said that there is a need to step up savings in the economy. The current account deficit (CAD) that finances the saving-investment gap has averaged less than 1% of GDP over past two decades. Even assuming a higher a CAD/GDP ratio of 2%, gross domestic saving (GDS) rate need to be raised by about 5 percentage points from 33.7% in 2009-10, RBI said. This underscores, the importance of augmenting saving as well as bringing about technological and institutional improvements to realize higher growth through higher investments and lower ICOR.

Overall investment requirements and the need for continued sustainability on current account, thus underscore the need for attaining the highs of private corporate and public sector savings reached in the recent past and exploring the possibility of invoking an upward shift in household savings which have remained stable for many years, RBI said.

RBI said there could be some pressure on CAD if the global economy weakens significantly and affects exports. With adequate foreign exchange reserves, India remains capable of handling any pressures emanating from the external sector in the near term. However, from a medium to long term perspective, it is important to improve resilience of external account by pursuing policies that shift the composition of capital flows so as to reduce dependence on its volatile components, RBI said. Augmenting foreign direct investment (FDI) further could bring about a better balance between different components of capital flows and reduce the possibility of volatile currency movements and any pressure on reserves in the face of contagion risks, RBI said.

RBI said tackling food inflation also needs a strategy to break the inertial element arising from rising real wages leading to increases in the Minimum Support Price (MSP), which in turn lead to higher food inflation that feeds back to higher wages with an element of indexation. Rural wage programmes need to be linked with productivity, RBI said. If productivity improves, real wages can rise without putting pressure on prices. The inclusion agenda can then be pursued on a sustainable basis without drag on inflation and the fiscal position.

Transmission of inflation from abroad has also been an important element in keeping inflation high in the recent years, RBI said. International commodity prices remain a potential threat as global liquidity is still far too large due to monetary policy accommodation by advanced countries, RBI said. Fuel and food security would need to be given particular attention. There is a need for environmentally sustainable solutions to manage energy security. Free pricing of petroleum products can help, as a large population cannot be subsidised in an import dependent item, RBI said.

The central bank also said that pricing power in the manufacturing sector has macro as well as micro angles. A competition policy has been put in place and industrial organisation structures could be studied along with price information to stamp out anti-competitive practices and collusive behavior. Such behavior also adds to inflationary pressures and needs to be curbed, RBI said.

RBI said inflation is likely to remain high and moderate only towards the latter part of the year to about 7% by March 2012. The recent decline in global commodity prices has not been very significant, RBI said. If the global recovery weakens ahead, commodity prices may decline further, which should have a salutary impact on domestic inflation, RBI said. The pass-through of the rise in global commodity prices so far has been incomplete, especially in the minerals and oil space. As such, the benefit of a moderate fall in global commodity prices on domestic price level would also be limited, RBI said.

If global crude oil prices stay at current level, further increase in prices of administered oil products will become necessary to contain subsidies, RBI said. Fertiliser and electricity prices will also require an upward revision in view of sharp rise in input costs, RBI said. The high and persistent inflation over the last two years has brought to the fore the limitation in arresting inflation in absence of adequate supply response. However, monetary policy still has an important role to play in curbing the second round effects of supply-led inflation, RBI said. In face of nominal rigidities and price stickiness, there are dangers of accepting elevated inflation level as the new normal, the central bank said.

The near-term prospects for agricultural sector remain good. Farm secretary P. Basu on 30 August 2011, said improved rainfall in August 2011 will likely result in record farm out in the crop year from that began on 1 July 2011. The rice output is expected to hit 86 million-87 million metric tonnes this year, a significant increase from the 80.65 million tons produced last year. Sufficient rainfall now will also leave enough soil moisture for winter-sown crop such as wheat, Basu said. Good rains could help boost rural income and may help bring down food inflation.

Meanwhile, Indian firms relying on European and US markets are worried about a likely economic slowdown in the US and Europe. Bilateral trade between India and the US stood at $36.5 billion in 2010.

Commerce Minister Anand Sharma recently said India's discussions with the European Union (EU) and Canada to form free-trade agreements are in advance stages. India aims to boost bilateral trade with Canada to C$15 billion (US$15.3 billion) a year by 2015 from about C$4.2 billion in 2010. With the 27-member EU, India had initiated discussions on the free-trade pact in 2007. The two sides originally hoped to conclude a wide-ranging deal by 2010 to boost trade to $237 billion annually by 2015. Their bilateral trade is currently worth about $92 billion.

As per a recent survey by a prominent investment bank, Corporate India will raise capital spending by tepid 10% in the year to March 2012 (FY 2012). Capital expenditure (capex) in FY 2012 will be concentrated on improving productivity rather than adding greenfield capacity, the investment bank said.