Cygnus - Economy & Industry Monitor

Cygnus - Economy & Industry Monitor

JP Morgan - HCL Technologies, UTI Bank, Economy

HCL Technologies

UTI Bank

Economy

Major economies promise to reduce imbalances

China on Saturday pledged to gradually increase the flexibility of its currency as part of broader policy measures agreed by five major economic players to address global economic imbalances.

A list of the measures was released after meetings of the International Monetary Fund's policy-setting committee by the five -- the United States, Japan, Saudi Arabia, China and euro-area nations -- following year-long talks led by the IMF.

But the policies simply represent an inventory of existing plans to reduce a gaping trade shortfall in the United States, introduce growth-enhancing reforms in the euro area and Japan, improve investment in oil-producing countries like Saudi Arabia, and cut China's heavy reliance on exports.

An IMF official noted the plans were more detailed than the Agenda for Growth, an initiative by the Group of Seven rich countries to address issues in their own countries that were generating imbalances.

"The implementation by each participant of these policies would in combination constitute a significant further step toward sustaining solid economic growth and resolving imbalances," the five parties said in a joint statement.

IMF Managing Director Rodrigo Rato said the statement showed a shared commitment to reducing the massive imbalances in trade and investment flows that many see as the global economy's Achilles' heel.

"One should not underestimate that these five economies ... have willingly accepted a joint document and shared responsibility on global imbalances," Rato said. "Of course, we will see how things evolve in the future."

John Lipsky, the IMF's No. 2 official, added: "There was agreement among each of the participants in the multilateral consultation that their proposals were in their own interests as well as in the general interest."

Lipsky and other IMF officials led talks between senior policy-makers from all five parties to persuade them to act to reduce imbalances, primarily big U.S. trade and budget gaps and hefty trade surpluses in Asia and oil-producing nations.

Among the policy-makers who participated were U.S. Treasury Under Secretary Tim Adams and Hu Xiaolian, the deputy governor of China's central bank.

MORE FLEXIBILITY

The IMF has long warned that failure to take action against imbalances raised the risk of abrupt and excessive changes in exchange rates and asset prices, and hotter trade disputes.

In the statement, China repeated a vow to increase the flexibility of its yuan currency, but it offered no timelines or targets.

It also promised to speed up banking system reform and spur domestic demand, saying cutting its trade surplus with the rest of the world would be a priority this year.

The statement noted that China had introduced greater flexibility in the yuan's exchange rate and said China's "foreign exchange market infrastructure has been significantly improved."

In July 2005, China abandoned a long-standing policy of pegging the yuan to the U.S. dollar. But it still keeps the currency, which has risen only 5 percent since Beijing's policy shift, on a tight leash.

As it has on numerous occasions in the past, China promised to move toward greater yuan flexibility over time.

"Exchange rate flexibility will gradually increase, with attention paid to the value of a basket of currencies," the statement said.

Some IMF and G7 sources said that language was significant because it meant that China was not only focusing on the U.S. dollar, which has been weak, but also on other currencies.

China also plans to boost household incomes and rural consumption as part of its efforts to stimulate demand. Beijing would also change export tax rebate policies in an effort to reduce its trade surplus, the statement said.

In its "to-do" list, the United States repeated it would strive to narrow its budget gap over the medium term, in part by reforming the budget process to contain spending growth, even as it raised tax incentives to spur private savings.

FIIs, economy and the common man

We have been reading about the large investments being pumped into the stock market by foreign institutional investors (FIIs). The current levels are unprecedented. But what is the larger picture? Is the impact of the FIIs limited only to the stock market or do the institutions have a larger role in the economy? To be more specific, how do FII flows affect the common man?

Taking a closer look at the funds flow, FIIs bring dollars to India which get converted into rupees in the inter-bank foreign exchange market. As the supply of dollars increase, the law of demand-supply starts operating and the rupee appreciates vis-à-vis the dollar.

Appreciation of the rupee

So, other things remaining constant, higher FII flows would help the rupee to appreciate. This allows Indian consumers to import goods (which are priced in dollars) at a cheaper price. However, an appreciating currency also makes our exports uncompetitive in the global markets. As India is a developing economy, it would be beneficial to have a weaker currency, improve exports and, thereby, generate higher domestic activity.

Higher forex reserves

Under normal circumstances, the Reserve Bank of India (RBI), would try to stem the the volatility of the rupee by buying dollars and selling rupees. The excess dollars bought by the RBI would accrue to the foreign exchange reserves. For an emerging economy such as India a higher level of forex reserves affords financial and economic stability and reduces the vagaries of global capital flows.

So, higher foreign (dollar) inflows into India usually translate into more rupee liquidity in the system. This increases the money supply and facilitates easy availability of credit (loans) from banks (thus the frequent calls from telemarketers, offering all kinds of loans).

Invest and capture gains

Thus, we can conclude that higher FII flows also aid in lowering the cost of borrowings. On the flip side, as liquidity is high and banks become keen to lend money than accept it, the rates paid on deposits and bonds would decline. An investment strategy in such a situation is to invest in bond mutual funds and capture the capital gains on the bond portfolio arising from lower interest rates.

The easy availability of credit and the lower borrowing costs increase consumption demand for housing, durables, cars and real-estate. This higher demand often leads to greater public and corporate investments, resulting in higher economic growth. This, in turn, raises the prosperity level and the general standard of living. More jobs are created and wages also rise. Taxes are also lower.

However, as the amount of money in the system grows rapidly, the goods and services available may not grow at the same rate, leading to inflationary pressures (higher prices for goods and services) and reducing the purchasing power of consumers. Such inflationary pressures can push the central banks to hike interest rates.

Creating wealth

From a different perspective, if the FII flows are high (relative to the country's stock market capitalisation), the demand-supply equation comes into play once again and the market tends to rise rapidly, creating more wealth for the investor. This positive wealth effect also often leads to higher consumption and greater demand for other asset classes such as gold, real-estate etc., which, in turn, fuels economic growth and inflation. Higher FII flows can, thus, be seen to help create wealth through higher asset prices.

In case there is a sharp reversal of flows — the funds start flowing out — the conditions mentioned earlier would be overturned. Strong outflows would result in higher interest rates, lower demand and consumption, lower forex reserves, a weaker rupee and falling asset prices.

India's success story

Thus, FII flows do have a great impact even on the common man. The large inflows are often cited by politicians and media as proof that India is a success story and that global investors are flocking in their hordes. It should be kept in mind that the so-called `global investor' can be very fickle. He goes where he perceives profits. If the tide turns, he would be the first to flee with the profits.

A sharp reversal of fund flows could result in economic and financial instability. India was relatively immune to the Asian crisis in the mid-1990s as its integration into the global financial market was not so strong. It may not be so lucky the next time around. India also needs to focus on long-term flows in the form of foreign direct investment to sustain the economic reform process.

Booming economy keeps sentiments upbeat

Booming economy keeps sentiments upbeat

Key points

• We feel the government's improved performance so far in this fiscal has been partially overlooked by the market and the same could act as a catalyst for a rally in the stock market during the run-up to the Union Budget 2008.
• In our last Market Outlook report dated October 06, 2006, we had stated that we expected an upgrade in the Sensex' earnings estimates going forward and we have witnessed an 11.4% earnings upgrade for FY2007E, in line with our expectations of a 10-15% earnings revision.
• The domestic scenario remains upbeat: On a year-on-year (y-o-y) basis, the gross domestic product (GDP) has grown by 9.1% and the Index of Industrial Production (IIP) has risen by 10.9% in H1FY2007 with a strong growth of 12.1% in the manufacturing sector.
• In Q3FY2007, no major surprises are expected on the earnings front. However since the Diwali festival fell in October in FY2007 and in November in FY2006, some purchases could have already got reflected in the higher Q2FY2007 numbers, especially for the automobile sector. Hence the y-o-y growth in the profits could be slightly muted for Q3FY2007 compared with that in Q2FY2007.
• US housing data continues to be weak; however the third quarter GDP numbers were better than expected. The huge inventory build-up is the main concern, which is feared to limit growth in the last quarter. The market is expecting the US Federal Reserve (Fed) to start cutting rates from March 2007 onwards.
• Normally, December is the year-ending month for most foreign investors, who prefer to allocate fresh funds from January onwards. However there has been a change in this pattern since FY2004 and we expect the foreign institutional investors (FIIs) to actively participate in the stock market during the run-up to the next year's budget. A study of the trend of FII activity in the Indian stock market over the past two fiscals reveals that 51% of the net investments for FY2005 and 50% of that for FY2006 were made between November and February.
• We continue to prefer domestic demand-driven stories like automobiles, banking, capital goods and cement.

Download here

India's economic growth accelerates

India's economic growth accelerated to 9.2 percent in the July-September quarter compared with a year ago, the government said Thursday, bringing it closer to China's sizzling growth rate.

Fueled by a brisk expansion of the services sector and a surge in manufacturing output, India's gross domestic product expanded at a faster pace than the 8.9 percent growth in the previous quarter.

The numbers beat expectations and prompted many analysts to revise their forecasts for the full fiscal year through March 2007.

"We are revising our full year growth estimate to 8.4 percent from 7.9 percent," said Shubhada Rao, chief economist at Yes Bank.

If that projection comes true, it would be the fourth straight year of 8 percent-plus growth for India, one of the world's fastest-growing economies after China, which grew 10.4 percent in the July-September quarter.

Some analysts expected GDP growth to moderate through the later part of the year because of high oil prices and a possible slowdown in global demand for Indian exports.

But manufactured output rose 11.9 percent during the July-September period compared with 8.1 percent in the same period last year. The growth was mostly driven by a surge in exports.

High oil prices have also pushed inflation and interest rates, and many thought that would also impact services such as transportation, banking and trade.

But the services sector, which accounts for more than half of India's GDP, continued to be buoyant. Trade, hotels and transport services expanded 13.9 percent, while financial services business grew 9.5 percent.

"The upside surprise relative to our forecast came almost entirely from the unexpected acceleration in service sector activity," said Rajeev Malik, a Singapore-based economist with JP Morgan Chase Bank.

JP Morgan was revising its forecast for India's economic growth in the current fiscal year to 8.4 percent from an earlier projection of 8 percent, he said.

Malik said he expects India's central bank to hike key interest rates by at least a quarter percentage point in December or January to keep inflation under check. "The Indian economy is not overheating, though the impressive growth momentum is showing some signs of excesses."

The sluggish performance of the agriculture sector, however, remained a concern. During the July-September period, farm output grew just 1.7 percent, sharply down from 4.1 percent in the same quarter a year ago.

About two-thirds of India's 1 billion people live on agriculture and most of them earn less than a dollar a day. They has been left untouched by India's economic boom over the past decade -- which has been driven by the expansion of industry and services.

Emkay - Economy Notes & Telecom Monthly

Download here

Want More Emkay Reports? Click on the labels below