RBI hikes repo rate, leaves other rates unchanged

Repo Rate – Increased to 7.25% from 7% Reverse Repo Rate – Unchanged at 6%
Bank Rate – Unchanged at 6.0 % Cash Reserve Ratio – Unchanged at 5 %

In a deft balancing act, the Reserve Bank of India increased the repo rate by 25bps to 7.25 percent, while leaving the reverse repo rate unchanged at 6 percent. Reverse repo rate and repo rate act as the floor and the ceiling providing a ‘corridor’ for the money market. Reverse repo rate is the overnight rate at which the central bank sucks out excess liquidity by selling securities in the market and repo rate is the rate at which it injects liquidity into the system by buying securities. Normally, a 100 bps spread is maintained between the two rates rates, but it has now been increased to 125 bbp. Bank Rate and CRR have also been left unchanged.

The announcement made in the mid-term review of the Annual Policy Statement for FY'07 came as a surprise for the market. Market was expecting a hike in reverse repo rate as well, in view of the pressure on inflation from a strong economic growth. Maintaining optimism about the economic growth, RBI has upped the GDP growth projection for 2006-07 to 8 percent from the earlier 7.5-8 percent. The central bank also maintains the year end (March 2007) inflation target at 5-5.50. Inflation reading for the week ended October 14 stood at 5.26%.

'Reddy' for another hike?

When the Reserve Bank of India reviews its monetary policy on October 31, will it raise the interest rates once again or will it wait and watch, giving the previous hikes more time to work? The central bank has raised the reverse repo rate three times this year by quarter percentage point each to 6 percent, to curb inflationary expectations stoked by strong economic growth.

The inflation has mostly remained within the RBI's comfort zone of 5-5.50 percent. But of late, it has started edging towards the higher end of the range. The latest data has shown the annual inflation measured by Wholesale Price Index at a four month high. The inflation for the week ended October 14 was at 5.26 percent - up from the previous week's figure of 5.16 percent, on account of higher prices for food, edible oils and textiles. Going ahead, the inflation numbers are expected to return higher readings because of low base effect and may inch up to 6%.

As the strong growth momentum keeps an upward pressure on inflation, RBI may have to do a bit more monetary tightening. Bond markets have been generally sanguine in the past couple of months. Yield on the 10 year benchmark government bond has fallen three quarters of a percentage point after touching an almost five-year high of 8.4 percent in July. This optimism may be misplaced. RBI may go in for a pre-emptive hike now rather than waiting for the next review when inflation may have gone beyond the March-end target of 5-5.50 percent. Even if RBI decides not to change the rates now, the tightening cycle is far from over.

Besides domestic growth considerations and inflationary expectations, RBI will also have to weigh the global scenario – US rates being on hold amid economic slowdown, strong growth and continued tightening bias in Euro-zone economies, sustained expansion in Japan and possible rate actions.

An update on ICBC IPO

After raising US$21.9 billion in the world's largest IPO, the Industrial & Commercial Bank of China (ICBC) has made its debut in China's first simultaneous listing on Shanghai and Hong Kong markets. While the Shanghai debut was a bit uninspiring with a modest gain of just 5 percent, the Hong Kong listing was along the expected lines marking a gain of 15%.

The IPO was oversubscribed 26 times. Four of China's banks have come out with initial public offers in the past one year and have seen strong demand particularly from overseas investors. China's surging economy, which is set to grow by more than 10% this year, has created strong demand for these banks’ shares. However, there are fears that banks have been overvalued, with questions raised over levels of bad debt.

Here's a list of the world's 10 largest IPOs till date (source: Reuters). It can be seen that 3 Chinese banks figure in the list.

Date Company Size (Billion USD)
Oct. 20, 2006 Industrial & Commercial Bank of China 21.9
Oct. 12, 1998 NTT Mobile Communications 18.4
Oct. 31, 1999 Enel 17.4
Nov. 17, 1996 Deutsche Telekom A.G. 13.0
May 24, 2006 Bank of China 11.2
Apr. 26, 2000 AT&T Wireless Services Inc. 10.6
July 14, 2006 Rosneft 10.4
Nov. 15, 1997 Telstra Corp Ltd. 10.0
Oct. 20, 2005 China Construction Bank 9.2
Nov. 18, 2005 EDF 9.0

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US rates on hold - what next?

The US Fed has decided to keep interest rates unchanged at 5.25%, but remains wary of inflationary risks to the economy. The decision to keep the rates on hold for the third consecutive month after a series of 17 successive hikes over past two years is on the expected lines. As before, Richmond Fed President Lacker was the lone dissenting member of FOMC favouring a quarter percentage point rise hike.

The Fed observed that economic growth has slowed over the course of the year, but going forward, the economy is expected to expand at a moderate pace. While recognizing that inflation pressures are likely to moderate over time, the FOMC continues to emphasise that “… some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”

The Fed's current 'watch and wait' policy on rates follows signs that price pressures are easing and that the economy has slowed since the start of the year. There has been perceptible easing of price pressures owing to lower energy prices, contained inflation expectations, cumulative effects of past monetary policy actions and other factors restraining aggregate demand, though the Fed does not want to let the guard down. On the other hand, there has been a noticeable output drop in the second quarter and the once-buoyant housing market has cooled considerably. The challenge before the Fed Policymakers is to control inflation while ensuring that the slowdown in economic activity does not worsen into a prolonged downturn.

The Fed's decision to keep its policy options open has left the market guessing on the future course of interest rates. Although it is widely believed that Fed will keep interest rates steady in the near future, the market is divided on the likely Fed action in 2007. On the one hand, as the Fed continues to warn on inflation risks, rate hikes may be required in future. On the other hand, there is a section of the market that believes that continued economic slowdown and weakness in the housing market may force the Fed to reverse the cycle and start cutting the rates sometime in second half of 2007.

Bulls, Bulls Everywhere
DJ 12K, Hang Seng 18K, Sensex 13K, ………

Stock markets across the world are scaling new heights - from US to Europe to Asia. From Wall Street to Tokyo, from Frankfurt to Singapore, from Paris to Manila, from Zurich to Mumbai – there is a bull party going on at the bourses everywhere.

Dow Jones Industrial Average is near its all time high and closed above the 12000 milestone this week registering a weekly gain of 0.4 percent, despite concerns that profit growth has peaked. European stocks rose for fourth consecutive week, led by metals and commodities stocks, as metal prices gained and OPEC agreed to cut oil production.

Hong Kong's Hang Seng Index is at 6-year high and ended the week at 18,113.55 with a weekly gain of 0.7 percent riding on the euphoria generated by the ICBC IPO and strong growth in China Mobile subscriptions. Japan's Nikkei 225 Stock Average added 0.7 percent this week to close at 16,651.63 reflecting robust corporate earnings - marking the fourth consecutive week of gains. South Korea's Kospi added 1.2 percent this week, as the tensions from North Korea's nuclear test ease with diplomacy likely to take the centre-stage. Shares in Singapore and Indonesia are also at new all-time highs.

In India, the BSE Sensex, though generally showing signs of fatigue during the week as it approached the psychologically important 13000 level, ended up on Saturday at a special 75-minute trading session arranged to mark the festival of Diwali. The blue-chip 30-share index had closed at 12,928.18 on Oct. 16 and has been a little hesitant since then. The overall positive sentiment and expectations of strong corporate earnings in the coming weeks is likely to propel the markets beyond 13000.

Of opaque flows, cuts and prices

Oil prices have continued to fall, despite a decision by OPEC to cut production by 1.2 million barrels per day (bpd). The targeted production cut is 200,000 bpd more than what was expected. The oil cartel's decision to cut production shows their discomfort with the continued fall in crude oil prices and their anxiety to defend a floor price which is seen somewhere near $60 a barrel. Oil prices have fallen about 25 percent from the record mid-July level of $78.40 a barrel to below $60 now.

There are, however, doubts in the market whether OPEC members will be able to deliver the targeted reduction. The talk of a 1 million bpd cut has been doing rounds for about a month and was already factored in. So, when the OPEC ministers met in an emergency meeting in Doha, they decided to give a strong signal to the market by announcing a larger reduction target and hinting at the possibility of further cuts when they meet again in Nigeria in December.

OPEC members supply about a third of the world's crude and are concerned about high fuel stocks in consumer countries, particularly in the US, and a projected drop in demand for OPEC oil in 2007 as competitors bring in more supplies. The decision to cut the production is described by OPEC as aimed at restoring the ‘equilibrium’ between supply and demand, which has been distorted by ‘over-supply’ and huge inventory levels. The skepticism on the member countries’ ability to deliver the agreed reductions has come from the deep divisions seen within the cartel on how to implement the cuts. The targeted reduction comes at a cost for the member countries, particularly for those who have heavily invested their petrodollars into building up their oil sectors.

Market movements in the coming weeks will show whether OPEC will be able to define the current price level as the floor for the medium term. A large section of the market believes that there may not be any rise in the prices in near future and the current declining trend may continue, given the large existing inventories and the uncertainty surrounding the production cuts. According to a Bloomberg News survey conducted just before OPEC announced its decision, prices may fall next week on doubts the producer group will cut production enough to reduce excess supplies. 21 of 49 analysts, traders and brokers covered in the survey said prices will decline, 14 forecast an increase and 14 predicted little change.

Mount 13K – An Arduous Climb for Sensex

The Indian stock markets have reached a new all-time high, leaving behind the memories of the “May Mayhem”. A month-long bear grip during May-June this year had knocked down the key indices by about 30%. The crash had been triggered by concerns on higher interest rates following a trend of monetary tightening across the world led by US Federal Reserve, as also high oil prices. These concerns have since receded, as US Fed has ended a two-year streak of interest-rate hikes and oil prices have dropped over 20 percent from record highs. Overseas investors have flocked back to the world’s second fastest growing economy in a big way, as the economy promises sustained growth.

The benchmark sensitive index Sensex of Bombay stock Exchange ended at 12736 on Friday, convincingly surpassing the record close of 12,612 set on May 10. This marks a gain of 45 percent in 90 sessions since the index hit a low of 8800. On a weekly basis, the 30-share index recorded a gain of 2.9 percent, when the quarterly earnings season got off to a flying start with Infosys numbers. More fireworks are expected in coming weeks as more and more numbers pour in. Most of the frontline stocks are likely to report robust earnings growth.

India, the Asia's fourth largest economy, is expected to grow by over 8 percent for the fourth year in a row. The economy grew 8.9 percent in the quarter ended June 30. The Indian growth story is now being seen as much more sustainable than ever before. The growth in Indian economy is expected to be led by the themes of strong domestic demand, outsourcing and infrastructure.

The overseas investors are looking to benefit from the rapid growth and the great long-term story that they expect to unfold. They put a record amount of US$10.7 billion into the Indian market last year and this year's net purchases have been US$5.37 billion. Since June 14, they've bought local shares worth US$2.77 billion, surpassing the amount they sold during the slump. Domestic investors are also contributing to the market's gains in a significant way. Domestic funds remained buyers of stock during the slump, purchasing shares worth $1.12 billion from May 10 to June 14. Since the low in June their purchases have amounted to US$1.78 billion.

Incidentally, the bulls are calling the shots on bourses across the globe. From Dow Jones in US to FTSE, CAC, DAX in Europe and Nikkei, Hangseng, Sensex in Asia – it’s bright and sunny everywhere.

What makes Chinese banks hot?

The world's biggest initial public offering coming from the largest bank of the world’s fastest growing economy has seen huge demand from institutional investors from across the world. The Industrial and Commercial Bank of China (ICBC) plans to debut in Hong Kong and Shanghai on Oct. 27. This will be the first IPO to be simultaneously listed on both stock exchanges.

If priced near the top of the range (which is almost certain), the issue will garner US$22 billion, beating the record of $18.4 billion set in 1998 by a Japanese mobile-telecoms operator NTT Mobile Communications Network Inc. The sale will also place ICBC among the ten most highly valued banks in the world, with a market capitalisation close to $130 billion.

ICBC is the latest in a series of massive IPOs launched by Chinese banks during the past year. Bank of China, the country’s second largest lender, raised US$11.2 billion with an IPO that was the fourth-largest on record. China Construction Bank, the mainland's no. 3 bank, raised US$8 billion in October 2005.

What makes Chinese banks ‘hot’? It’s the strong growth recorded by these banks in the sizzling economy that is luring the institutional investors. There is a scramble among the financial powerhouses of the world like Goldman Sachs, Morgan Stanley and Citigroup to gain a foothold into the Chinese banking system. For them, these banks are a sort of a proxy for China itself: vast, diverse, growing fast, and with extraordinary scope for internal restructuring. Economist terms the ICBC IPO as a single transaction that could sum up the knowns and unknowns surrounding China's red-hot economy. According to an Economist article, “…ICBC, however valuable, also reflects the murkier side of life in the Chinese economy. Political considerations often come first, information is unreliable, and openness in the banking system is questionable, despite conditions tied to China's entry into the World Trade Organisation.”

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On the ECB Interest Rate Hike

The European Central Bank (ECB) has once again raised the benchmark lending rate by 25 bps to 3.25%, while leaving the door open for further tightening. This is the fifth quarter percentage point hike since December last year and was widely expected. Meanwhile, the Bank of England has kept rates unchanged at 4.75%.

The ECB move comes in the wake of the fastest economic expansion in the Euro-zone since 2000 and the need to maintain “strong vigilance'' on inflation. The ECB, which sets interest rates in the 12 Euro-zone economies, is trying to keep inflation under control and is also worried about a furious growth in household borrowings in some of the member economies.

Though energy prices pulled the consumer price index below 2% in September for the first time in 21 months, it is widely expected that it may rise back above 2% soon. ECB President Trichet assessed that inflation expectations were well anchored but at year end inflation could very well be substantially over and above 2%, even without a change in oil prices.

Analysts are almost unanimous in their expectation of one more hike before year end. Opinion is, however, divided on the outlook for next year. In a Bloomberg survey of economists, 11 of the 23 expected that rates will stay on hold through 2007, nine predicted increases to as high as 4 percentand three forecast a cut to 3 percent.

In US, the Federal Reserve left its funds rate unchanged for a second straight meeting on Sept. 20, after raising it 17 times since June 2004 to 5.25 percent. US accounts for about a fifth of Europe's exports and a slowdown there may affect European economies. An array of soft economic data in US has given rise to expectations that the Federal Reserve may cut rates next year.

Sensex weak ahead of earnings season

Friday was a day of range-bound movements on Indian bourses. The market finally ended almost flat after alternating between positive and negative territory. Positive cues from the US markets were ignored amid the cautious mood ahead of the quarterly earnings season.

The 30-share BSE Sensex lost 16.60 points to finish at 12,372.81. Nifty, the broader 50-share index of NSE, closed up 4.8 points at 3569.70. This marks the first weekly loss for Sensex and Nifty after 10 weeks of gains.

Elsewhere in Asia also, the stocks ended a little down on Friday. Japan's benchmark Nikkei 225 dipped 13.27 points to 16,436.06, while Hong Kong’s Hang Seng was down 4.28 points to 17,903.39. On a weekly basis, Nikkei has gained 1.9 percent this week after business confidence unexpectedly rose to a two-year high. Hang Seng is very close to the psychologically important level of 18,000 and may face some resistance going ahead.

In India, Sensex is within a kissing distance of its all-time high reached in May this year. A sharp fall had been witnessed in May in line with global trends and other emerging markets, triggered by the meltdown in the metals market and worries of rising US interest rates. Now the overall market sentiment is positive, as the economy continues to post robust growth.

With the earnings season for Q2 2006-07 kicking off next week, there is a certain amount of caution, as the expectations have been very high. The tone for the season will be set by the bellwether Infosys and other biggies in the IT pack. Besides IT, other key sectors whose results will be keenly watched are banking, automobile and FMCG. Any disappointments here will affect the sentiments and the market direction. Numbers from metals and sugar sectors will be watched for confirmation of the views on slackening momentum.

Asian stocks retreat

Asian stocks declined on Tuesday from a four-week high, tracking a sluggish performance of US markets yesterday amid weak economic data.

US stocks had ended weak on Monday, with Dow Jones Industrial Average retreating after flirting with the historic high achieved in January 2000. The weakness followed a weaker-than-expected US manufacturing data. The ISM manufacturing index dropped to 52.9 last month from 54.5 in August, signaling that a slowdown in housing may have spread to other areas of the economy. A prospect of a weakening of the world’s largest economy fuels concerns in Asian economies, as US happens to be the region’s largest export market.

Japan's Nikkei 225 index lost 0.1 percent today to close at 16,242.09, after touching a low of 16,148.89. The decline comes after four days of gains fueled by optimism about the economy shown in upbeat economic data and business sentiment survey.

In Hong Kong, on the other hand, share prices moved up, mainly driven by strong demand on large Chinese financials in view of strong gains in the Chinese currency. The blue-chip Hang Seng Index rose 63.48 points, or 0.4 percent, to 17,606.53.

Mirroring the decline in US markets and the general trend in Asia, Indian stocks also faced some selling pressure from funds and investors. The 30-share Sensex on Bombay Stock Exchange lost 88.03, or 0.7 percent, to 12,366.39. The broader 50-share Nifty Index on the National Stock Exchange declined 18.80, or 0.5 percent, to 3569.60.

The decline was led by IT heavyweights, with Infosys losing 1.6%, reflecting the concerns on US economy. US accounts for about 60 percent of the market for Indian software biggies. Another factor weighing on the market sentiment was the impending earnings season, when companies will report their quarterly earnings. Other major losers of the day were HDFC, HLL, Ranbaxy, Tata Power, Cipla, L&T, Maruti, OBC and Wipro.

US stocks are trading higher on Tuesady, as oil prices continue to decline. The blue-chip Dow Jones Index again crossed its highest-ever close of 11,722.98, set in January 2000, for a fourth straight session today.

Dow Jones at all-time high

The blue-chip Dow Jones industrial Average Index has surpassed the record close of 11,723 reached in January 2000, amid mixed economic news and lower oil prices. The earlier peak had been reached in 2000 at the height of the tech bubble.

While crude has fallen below $62 a barrel (over 2% decline), the widely tracked ISM Manufacturing Index, a key indicator of national industrial activity, showed a weaker-than-expected reading. The Manufacturing Index posting a reading of 52.9 still reflected steady overall growth. Meanwhile, a government report on construction showed a surprise rise in construction spending and a realtors’ report on home re-sales suggested that the slowdown in housing would be gradual. Lower oil prices and a cooling economy ease the inflation concerns and provide more flexibility to the Fed.