RBI raises repo rate

RBI has raised the short-term repo rate by 25 bps to 7.50 per cent, while keeping reverse repo (6 per cent), bank rate (6 per cent) and CRR (5.50 percent) unchanged.

Concern over surging inflation is the dominant theme of the quarterly review of monetary policy and the hike is on expected lines as the central bank had given enough indications in its macroeconomic review that it is worried about the underlying inflationary pressures. Inflation, which had breached the 6 per cent mark in the first week of January, had eased marginally to 5.95 per cent in the following week ended January 13. The RBI’s year target band for inflation is 5-5.50 per cent. Meanwhile, the Government on its part has taken a series of fiscal measures to rein in the rising inflation.

Repo rate is the rate at which the central bank buys securities to infuse liquidity in the system and reverse repo rate is the rate at which it sucks out excess liquidity by selling securities in the market. The daily repurchase window is expected to provide a ‘corridor’ for the overnight rates, with reverse repo rate and repo rate acting as the floor and the ceiling respectively. By increasing the repo rate while keeping the reverse repo rate unchanged, RBI has widened the spread to 150 bps which has traditionally been maintained at 100 bps. Interbank overnight rates tend to stay near the repo rate in a situation of tight liquidity as prevailing now.

Echoing the all-pervasive bullish outlook on economy, the RBI has revised upwards the GDP growth projection to 8.5 to 9 per cent in 2006-07 as compared to 8 per cent projected in mid-term review and 7.5 to 8 per cent earlier. On inflation, it observed prices of food articles would have considerable impact on headline inflation over the rest of the year. The seasonal decline in prices of food articles in the second half of the year has been less than normal. The prices of manufactures are firming up and were close to the headline level by the end of December.

The central bank has re-iterated its worries on continued high credit growth in the real estate sector, also identifying outstanding credit card receivables, loans and advances qualifying as capital market exposure and personal loans as a matter of concern. It says, there are abiding concerns relating to the persistently high credit growth and the potential for erosion in the quality of credit so that balance sheets of banks need to be fortified against the build-up of loan delinquencies by precautionary provisioning and a greater sensitivity to underlying risks by enhancement of risk weights applied to advances to specific sectors in which banks’ exposures have been rising at a fast pace.

Significantly, RBI has signaled in its statement that more interest rate hikes are on the cards, as the economy continues to grow ferociously and containing inflation takes priority in policy. RBI mentions that early warning signals emanating from rising inflation in an environment of high money and credit growth indicate that monetary policy is still accommodative, warranting a policy response in terms of a measured increase in interest rates to assuage demand pressures. The stance of monetary policy has progressively shifted from an equal emphasis on price stability alongside growth to one of reinforcing price stability with immediate monetary measures.

S&P raises India's rating to investment grade

Global rating agency Standard & Poor's has raised India's sovereign credit rating to investment grade, citing the country's strong economic outlook, its rising foreign exchange reserves and the improved regulation of its stock and bond markets.

Gradual reforms and consistent monetary and fiscal policy stances have sustained macroeconomic stability and India's huge foreign-exchange reserves provide a buffer against changes in investor confidence, according to the agency. The foreign exchange reserves, which totaled about US$176 billion at the end of 2006, are more than 16 times of India's outstanding short-term debt.

India's GDP has clocked an average of over 8 percent growth in the past three years and the economy is expected to grow a record 9 percent in the current fiscal year ending March 2007. The rating upgrade from BB+, the highest junk rating, to BBB-, the lowest investment grade rating, will help improve India’s credit standing and reduce the borrowing costs in the global market.

S&P said India's fiscal position has improved and the country has a "well-functioning" bond market, which provides long-term financing of government deficits. The central government's budget deficit for the current year seems­ to be back on track to meet its target of 3.8 per cent of GDP due to strong revenue collection. The secular decline in general government deficits in the medium term is likely to continue due to tax reform and improved administrations and implementation of fiscal responsibility laws across more states, currently enacted by 23 out of 29 states, according to the rating agency’s assessment.

Further rating improvements will, however, depend on sustained prudent fiscal policy that leads to a decline in government debt and interest burden, and further reforms that lift the country's growth prospects and income levels.

Bank of Japan's assessment of economic & financial developments

The Bank of Japan’s policy board decided, in a 6-3 vote, to keep its benchmark interest rate steady at 0.25 percent, leaving the impression that the central bank has bowed to political pressure to move slowly. The political establishment has expressed concerns that raising rates too quickly will choke off the nascent recovery, as the economy faces weak consumer spending and no clear signs of inflation.

In its Monthly Report of Recent Economic and Financial Developments January 2007 released on 18th January, BoJ has said that the developments have so far deviated slightly downward from the outlook presented in October 2006, mainly due to weaker-than-expected private consumption. Looking ahead, the bank expects that the economy will develop broadly in line with the outlook, as a virtuous circle of production, income, and spending is likely to remain intact. Here's the text of the report.

Japan's economy is expanding moderately.
Exports have continued to increase, while public investment has been on a downtrend. Business fixed investment has continued to increase against the background of high corporate profits. Household income has also continued rising moderately. In this situation, private consumption has been on an increasing trend, although the pace of increase has been only modest. Housing investment has been increasing moderately with some fluctuations. With the rise in demand both at home and abroad, production has also been increasing.

Japan's economy is expected to continue expanding moderately.
Exports are expected to continue rising against the background of the expansion of overseas economies. Domestic private demand is likely to continue increasing against the background of high corporate profits and the moderate rise in household income. In light of these increases in demand both at home and abroad, production is also expected to follow an increasing trend. Public investment, meanwhile, is projected to remain on a downtrend.

On the price front, domestic corporate goods prices have recently been somewhat lower than their levels of three months earlier, due to the drop in international commodity prices. The year-on-year rate of change in consumer prices (excluding fresh food) has been on a positive trend.

Domestic corporate goods prices are expected to be somewhat weak or stay flat in the immediate future, due to the drop in international commodity prices. The year-on-year rate of change in consumer prices is projected to continue to follow a positive trend, as the output gap continues to be positive.

As for the financial environment, the environment for corporate finance is accommodative. The issuing environment for CP and corporate bonds is favorable. Also, the lending attitudes of private banks have continued to be accommodative. Credit demand in the private sector has been increasing. Under these circumstances, the amount outstanding of lending by private banks has been increasing. The amount outstanding of CP and corporate bonds issued is slightly below the previous year's level. Funding costs for firms have risen slightly. Meanwhile, the year-on-year rate of change in the money stock is at the 0.0-1.0 percent level. As for developments in financial markets, in the money markets, the overnight call rate has been at around 0.25 percent, and interest rates on term instruments have been around the same level as last month. In the foreign exchange and capital markets, stock prices have risen compared with last month, while the yen's exchange rate against the U.S. dollar has fallen compared with last month. Meanwhile, long-term interest rates have been around the same level as last month.

Developments in Japan's economy have so far deviated slightly downward from the outlook presented in the Outlook for Economic Activity and Prices (the Outlook Report) released in October 2006, mainly due to weaker-than-expected private consumption caused partly by temporary downward pressure stemming from the unfavorable weather conditions. Looking ahead, however, the economy is expected to develop broadly in line with the outlook, as a virtuous circle of production, income, and spending is likely to remain intact. As for prices, domestic corporate goods prices are expected to deviate slightly downward from the expected trajectory, reflecting the drop in crude oil prices. Consumer prices have so far deviated slightly downward from the projection, partly reflecting the drop in crude oil prices, but they are expected to develop broadly in line with the projection.

OIL MARKET REPORT - HIGHLIGHTS

Following are the highlights of the latest oil market report released by the International Energy Agency (dated 18 January 2007):

Crude oil prices fell to 20-month lows in mid-January as lower demand, due to unusually warm weather and fund repositioning in commodity markets, offset the impact of OPEC cuts. Despite a sharp fall in US crude stocks, high inventories at the NYMEX delivery point of Cushing, Oklahoma, are contributing to the persistence of higher forward prices.

Global oil product demand has been cut by 450 kb/d in 4Q06 following large US data revisions, unseasonably mild temperatures, fuel switching and lower apparent demand in the FSU. Some of these factors, together with a lower US GDP assumption, contribute to a reduction in forecast global demand growth to 1.6% in 2007 (85.8 mb/d).

World oil supply rose by 110 kb/d in December to 85.4 mb/d, as strong recent non-OPEC growth continued. However, revisions to Norway, Mexico, Canada and Latin America lowered non-OPEC supply by 0.3 mb/d to 52.3 mb/d in 2007. Mild weather cut the 4Q06 ‘call on OPEC plus stock change’ to 29.4 mb/d, but the 2007 call was lifted by 0.1 mb/d to 28.6 mb/d, only marginally below the average call in 2006.

December OPEC-11 crude supply fell by 155 kb/d to 28.8 mb/d, but persistent disruptions to Iraqi and Nigerian supply limit effective spare capacity to 2.5 mb/d. Indications of further cuts in 1Q OPEC output follow the recent fall in prices and an agreement in Abuja to curb supply by 500 kb/d from February. Angola became an OPEC member from January 2007.

OECD refinery throughputs increased by 1.1 mb/d in November to average 39.1 mb/d. Weekly data suggest a further increase of 0.6 mb/d in December to a winter peak of 39.7 mb/d. Global throughputs are expected to decrease over the course of the first quarter, as maintenance takes place sequentially in the US, Europe, the Middle East and Asia.

OECD total industry oil stocks continued to decline in November, falling by 33 mb as product draws offset a modest crude oil stock build. Provisional data suggest the trend continued in December. While total OECD stocks are 41 mb higher than one year ago at 2,712 mb, forward demand cover fell by one day from October to 54 days.

The politics and the economics of interest rates

Bank of Japan has decided to keep the borrowing rates unchanged at 0.25 percent, concluding that it is too early to raise rates. Recent signs of slowing growth have prompted worries that Japanese economy could be faltering after five years of slow but steady growth. The central bank of the world’s second largest economy cited weaker-than-expected private consumption and growing downward pressures on domestic prices as the reason for going against an increase. BoJ had raised the level of borrowing rates by a quarter point to 0.25% last July, ending a long period of zero rates and another increase was widely expected as the economy has been doing well. The bank maintains its stance of gradually adjusting interest rate levels based on the economy and prices, though some recent comments by bank officials seemed to favour a rate increase. The decision is also being scrutinised from political angle - for the central bank's ability to maintain independence in its conduct of monetary policy.

Oil sees sub-50, still seeking bottom

Continuing its falling spree, oil briefly fell below $50 per barrel this Thursday before recovering slightly on Friday. Crude oil has shed about 18% in 12 sessions of 2007 and the sub-50 level has been seen for the first time in 20 months.

Weeks of mild winter weather in the U.S. Northeast, a key consumer of heating fuels, and growing energy stockpiles amidst doubts on OPEC’s ability to effect production cuts have been driving the recent fall. OPEC has committed itself to a total cut in output of 1.7 million barrels per day, including a 500,000 barrel-a-day reduction set to begin February. But the oil cartel is believed to have cut output by little more than half of its pledged levels. Production remains near 27 million barrels a day or about 700,000 barrels a day above OPEC's target.

OPEC member Saudi Arabia, which is also the world's biggest oil exporter, has been vocal about not making further production cuts and has instead said it plans to increase its crude oil production capacity nearly 40 percent by 2009 and double its refining ability during the next five years to keep pace with growing global demand.

Although crude oil for February delivery at NYMEX managed to close above $50 per barrel, it's expected to keep its date with sub-50 level. It should trade in a $40-50 band in the near future - a level where most of the consumers, notably developing economies like India, will be comfortable.

OIL – ALL’S NOT WELL

The southward movement of oil prices continues. NYMEX crude slipped last week below $52 a barrel before rebounding to $53 on Friday. While mild weather has been the prime driver in the recent downward movement, future direction will depend on a host of forces, including the stance OPEC is going to take (also the OPEC’s capacity to deliver production cuts and influence prices - OPEC's credibility has been on the wane), hedge fund speculators (a number of funds are taking short positions, on bets that prices will fall) and the strength of the global economy (which will affect the demand going ahead). Also on the market’s radar will be the geo-political developments especially in the middle east, though worst of the fears are already discounted.

The prices are expected to go below $50 very soon. Some analysts are even predicting the drop to extend to $40 a barrel, a price not seen since 2004. Crude oil has been in an eight-year bull market until last summer’s high above $78 a barrel. In 1998, oil traded as low as $10.35.

Bank of England surprises with rate hike, ECB holds

Monetary policy and central bank actions need not always be boring. Bank of England has delivered an exciting story to the markets, by raising its base rate by another quarter-point to 5.25%. This follows two earlier hikes of same magnitude, as part of an effort to stem inflationary pressures – one in November last and another one in August, the hike in August being similar to the latest one in surprise element.

The European Central Bank, on the other hand, decided to hold rates steady while hinting at an increase later this quarter.

The Bank of England’s move is spurred by worries on creeping inflation which reached 2.7 percent in November — above the bank's target of 2 percent for the seventh month in a row. Given the expectations that inflation may rise further, the BoE's pre-emptive strike looks sensible. What surprised the markets is the timing of the move. It was widely expected that the central bank would wait until February, when it would take stock of the economy as part of its quarterly review of inflation prospects.

The ECB, meanwhile, left its benchmark rate unchanged at 3.5 percent, but President Trichet's comment that it would engage in "very close monitoring" of inflation risks is taken as a signal that a quarter-point hike could be on the cards for March. Annual inflation in the euro zone was at 1.9 percent in December, just below the ECB's target of about or below than 2 percent.

The ECB's forecasts for euro-zone growth this year are between 1.7 percent and 2.7 percent, up from 1.6 percent and 2.6 percent issued last year. For next year, GDP growth is expected to be between 1.8 percent and 2.8 percent. While Trichet said euro-zone inflation is expected to hover at around 2 percent this year and in 2008, analysts expect inflation to rise above the ECB's target early this year and lead to a rate increase in March. The ECB sets policy for 13 nations with more than 316 million people and a combined gross domestic product that accounts for more than 15 percent of the world's economy.

Red ink on the bourses,

Bears are coming back .....

After recording strong gains last year – though punctuated by unprecedented volatility - Indian stock markets have begun the year 2007 on a hesitant note. Are bears coming back? Or is it the usual caution ahead of the earnings season?

Sensex shed over 200 points on Monday, as investors pressed sell button in line with other Asian markets. The fall was led by frontline IT stocks on concerns that the appreciation of the rupee and a slowdown in the US economy might hurt earnings of software. This is the third consecutive day of fall in Indian equity market.

While the 30-share blue-chip index of the BSE today ended 208.37 points down at 13,652.15 (-1.50%), NSE’s Nifty closed 50 points down at 3,933.40 (-1.26%). Besides IT stocks, heavy selling was seen in auto and metal counters. Overall breadth of the market was, however, positive and some buying was seen in mid-cap and small-cap scrips.

The quarterly earnings season kicks off later this week with Infosys results on 11th. While the incoming numbers will drive the sentiments in the coming weeks (and, numbers and guidance are generally expected to be good), there are some uncertainties going ahead. Although economy is expected to post robust growth, there are concerns ranging from high valuations, uncertainty in the metals market to looming interest rate hikes.

China hikes reserve ratio to cool liquidity growth

In a bid to rein in bank lending and cool liquidity surge in the booming economy, China's central bank has announced another increase in the reserve requirements. The 50 bps hike will be effective from 15th January, bringing the effective rate to 9.5% and follows a series of tightening measures last year - three 50 bps hikes in the reserve ratio and two 27 basis-point hikes in lending rates.

Chinese monetary authorities are worried about the prospects of an overheating in the economy and surging liquidity leading to asset price bubbles. Controlling liquidity has, therefore, been a high priority. The central bank has expressed concerns on various ocassions about the surfeit of liquidity in the system and is expected to follow-on with more rounds of hikes. The "excessive" liquidity in the world's fastest growing economy is building up from large trade surpluses and capital inflows.

Oil Prices South-Bound

First week of the New Year marked the sharpest fall in two years for crude oil prices – a weekly loss of about 8%. The fall comes amidst continued mild weather in the north-east coast of the US and ample supplies of petroleum products. On Friday, the prices recovered slightly, helped by a better-than-expected US jobs report for December. US light crude oil settled 72 cents up at $56.31 a barrel in New York and London's Brent crude rising 53 cents to $55.64. The overall sentiment, however, looks to be bearish.

The crude prices have been falling despite two production cuts agreed on by OPEC members - 1.2 million barrels a day in November and 0.5 million barrels per day beginning February next. The continued price fall reflects the market belief that members of the oil cartel are not adhering to the agreed production cuts.

While weather has been a key driver of sentiments in recent weeks, the drop in oil prices is accompanied by a simultaneous drop in other commodities as well. With global outlook for commodities being not-so-bullish, significant shifts in asset allocation of investors is expected in the year ahead. This may mark a halt in the bull run in commodities. The informal 'floor' price for crude oil that OPEC wants to defend - understood to be $60 a barrel - has been convincingly breached and next few weeks may even take the price below $50, as little support is seen forthcoming at current levels.

Top Business Stories of 2006
Housing slump on top, corporate scandals dominate

The slowdown in US housing market – marked by a sudden stall in home sales, home construction and home prices - has been voted as the top business story of the year by U.S. newspaper and broadcast editors surveyed by the Associated Press. The world has been keenly watching as to what the housing slump means for the economy and how the US Fed is going to respond. Also, how all this will affect the rest of the world economy.

Stories relating to corporate scandals dominate the list – Enron, options backdating scandal and the HP spying case. While the climb of Dow Jones to a new peak features at no. 10, the troubles of US automakers are ranked higher. Other stories included in the list of top 10 business stories are the surge in oil and gas prices, a pause in the interest rate hikes by US Fed and China's economic growth with burgeoning trade surplus with the US. Here is the top 10 list –

1. Housing slips
2. Enron's final act
3. Backdating scandal
4. Auto woes
5. Oil prices
6. Fed halts
7. Gas prices
8. HP spying
9. China tiger
10. Record Dow

Besides top 10, these are some other important stories listed by the survey - private equity on a buying spree, Warren Buffett's philanthropy, sagging sales at Wal-Mart, steping down of Bill Gates as chief software architect at Microsoft, Google's purchase of YouTube and AT&T -BellSouth deal .

A list of top 10 business stories selected by MSNBC.com features the stock market surge as its top story and housing slump at number two. Here goes the complete list-

1. Wall Street surges
2. Housing slump

3. HP spy scandal
4. Enron's final chapter
5. Motown struggles
6. Gas prices soar
7. Wal-Mart assailed
8. Backdating scandal
9. Gates to step down
10. Fed snaps streak

While saying that “2006 was a wild year” - from Wall Street records to soaring gas prices, MSNBC has this to say on its top story:

"As recently as mid-July, it was looking like another ho-hum year for Wall Street. After a dispiriting spring slump in the stock market, the major indicators were barely above water for the year. The economy was showing signs of slowing, and gas prices were driving energy sharply higher.

That's when the stock market began its biggest rally in years, propelling the bellwether Dow Jones industrial average through a record close that had stood unchallenged for more than six years. The Dow soared through the 12,000 barrier and kept going, closing at a record high 21 times at last count. Over five months the broad Standard & Poor's 500 jumped more than 15 percent, leaving the market poised for its best year since 2003, when it was bouncing back from an awful three-year bear market.

Much of the rally was driven by wealthy individuals pouring money into hedge funds, which snapped up dozens of publicly held companies and drove share prices higher. By year's end, Wall Street executives were rolling in greenbacks, with at least two CEOs raking in more than $40 million each in year-end bonuses.”

The other big story of the year is “Housing market slides after long boom” :
“The era of Americans using their homes at ATMs ended this year as the housing market's rapid cooling. With sales and appreciation rates falling or leveling in most markets, former Federal Reserve Chairman Alan Greenspan in May flatly declared “the boom is over.” ..

…… As 2007 approached there was cause for some optimism amid the bleak outlook. BusinessWeek reported that interest rates should stay at historic lows and predicted -– for those in it for the long haul –- the market might actually be poised for a 2009 comeback. The magazine noted, however, that home prices will continue to fall and price appreciation will slow in most markets throughout 2007.”

My Wish List for 2007

As we enter 2007, I hope that the US economy will escape the looming recession, rest of the world will find ways to offset the effect of the US slowdown, there will be fewer scandals in the corporate world, less volatility in the financial markets, more wealth creation with progress towards more equitable distribution, steps to contain the climate shifts and of course fewer wars.