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August 2, 2009 A FIN–NICHE PRESENTATION Webmail: email@example.com FIN-NICHE August 2, 2009 COVER STORY INFLATION Inflation is defined as a phenomenon of rise in the price level of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. Inflation is also erosion in purchasing power of money, which is a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the rate of inflation which is the annualized percentage change in a general price index. Let us take an example of a product costing Rs. 100 per kg last year. If the rate of inflation is 10% then it will cost Rs. 110 this year. In other words Rs. 100 will be able to buy a lesser amount of product, which shows an erosion of the purchasing value of the currency. Measures of Inflation: The two most widely accepted ways to calculate inflation are Consumer Price Index (CPI) and Wholesale Price Index (WPI). Consumer Price Index: It measures the average price of the commodities and services that are purchased by households. It measures a price change for a constant market basket of goods and services from one period to the next within the same area (city, region, or nation). It is determined by measuring the price of a standard group of goods meant to represent the typical market basket of a typical urban consumer. The percentage change in the CPI is a measure of estimating inflation. This method of calculating inflation is used in USA, UK etc. Wholesale Price Index: It is the price of a representative basket of the wholesale goods. It may consist of over 2,400 commodities. It tracks the price movement of each commodity individually. Based on this individual movement, the WPI is determined through the averaging principle. Unlike the CPI, WPI mainly focuses on the price of goods traded between corporations, rather than goods bought by consumers. The purpose of the WPI is to monitor price movements that reflect supply and demand in industry, manufacturing and construction. This helps in analyzing both macroeconomic and microeconomic conditions. FIN-NICHE August 2, 2009 This method of calculating inflation is used in India, Philippines etc. The Indian WPI figure is released every 10 days. Effects of inflation Negatives High or unpredictable inflation rates are regarded as harmful for an economy. They add inefficiencies in the market make it difficult for companies in budgeting and long term planning. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation. Uncertainty about the future purchasing power of money discourages investment and saving. And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates. With high inflation, purchasing power is redistributed from those on fixed incomes such as pensioners towards those with variable incomes whose earnings may better keep pace with the inflation. This redistribution of purchasing power also occurs between international trading partners. Where fixed exchange rates are imposed, rising inflation in one economy will cause its exports to become more expensive and thus affect the balance of trade. There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation. Cost-push inflation: Rising inflation can prompt employees to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In a sense, inflation leads to further inflationary expectations. Hoarding: People buy consumer durables as stores of wealth in the absence of viable alternatives as a means of getting rid of excess cash before it is devalued, creating shortages of the hoarded objects. Hyperinflation: If inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply. This happened is Zimbabwe. Allocative efficiency: A change in the supply or demand for a good will normally cause its price to change, signalling to buyers and sellers that they should re-allocate resources in response to the new market conditions. But when prices are constantly changing due to inflation, genuine price signals get lost in the noise, so agents are slow to respond to them. The result is a loss of allocative efficiency. FIN-NICHE August 2, 2009 Business cycles: According to the Austrian Business Cycle Theory, inflation sets off the business cycle. The economists hold this to be the most damaging effect of inflation. Artificially low interest rates and the associated increase in the money supply lead to reckless, speculative borrowing, resulting in clusters of mal-investments, which eventually have to be liquidated as they become unsustainable. Positives Labour-market adjustments: Since the nominal wages are slow to adjust downwards, prolonged disequilibrium and high unemployment in the labour market can result. Since inflation would lower the real wage if nominal wages are kept constant, some inflation is good for the economy, as it would allow labour markets to reach equilibrium faster. Debt relief: Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the inflation rate. Room to manoeuvre: The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which banks can borrow from the central bank, and open market operations which are the central bank's interventions into the bonds market with the aim of affecting the nominal interest rate. A moderate level of inflation tends to ensure that nominal interest rates stay sufficiently above zero so that if the need arises the bank can cut the nominal interest rate. Tobin effect: A moderate level of inflation can increase investment in an economy leading to faster growth or at least higher steady state level of income. This is due to the fact that inflation lowers the return on monetary assets relative to real assets, such as physical capital. To avoid inflation, investors would switch from holding their assets as money (or a similar, susceptible to inflation, form) to investing in real capital projects. WPI in India Some Economists argues that WPI does not properly measure the exact price rise an end- consumer will experience because, as the name suggests, it is at the wholesale level. Further more than 100 out of the 435 commodities included in the Index have ceased to be important from the consumption point of view. For example, a commodity like coarse grains that go into making of livestock feed. This commodity is insignificant, but continues to be considered while measuring inflation. FIN-NICHE August 2, 2009 India constituted the last WPI series of commodities in 1993-94 but has not updated it till now. The Economists argue the Index has lost relevance and cannot be a true indicator of inflation. So why is India not switching moving towards the CPI method of calculating inflation, which a far more rational and widely accepted method of calculating inflation? Finance ministry officials say that there are some intricate problems from shifting from WPI to CPI model. First of all, they argue that there are four different types of CPI indices in India, and switching over from WPI is risky and unwieldy. The four CPI indices are: CPI Industrial Workers CPI Urban Non-Manual Employees CPI Agricultural labourers; and CPI Rural labour. Secondly, since there is too much of lag in reporting CPI in India it is not feasible. In fact, as of May 21, 2008 the latest CPI number reported was for March 2006.The WPI is published on a weekly basis and the CPI, on a monthly basis. FIN-NICHE August 2, 2009 SENSEX Market Analysis Better-than-expected earnings from India Inc, strong global cues and sustained buying by foreign funds helped the key benchmark indices extend gains for the third straight week. A majority of the Q1 June 2009 results surpassed analysts' expectations with lower costs helping bottom-line growth. The combined net profit of 1921 companies rose 20.50% to Rs 71437crore on 5.1% fall in sales to Rs 673497crore in Q1 June 2009 over Q1 June 2008. The Bombay Stock Exchange’s SENSEX jumped 291.35 points or 1.89% to close at a 52-week closing high of 15,670.31 in the week ended 31 July 2009. A huge buying interest was noticed on the first day of August Series and closed the July Derivative expiry on a strong note, up 8% during the month. The Broader based NIFTY or The National Stock Exchange gained 65 points to close above the psychological 4,600 level (closed at 4636 on 31st July, Friday). Following the rally, the BSE Mid-Cap index jumped 189.21 points or 3.52% to 5,571.02 and the BSE Small-Cap index rose 155.63 points or 2.57% to 6,205.83 The benchmark SENSEX got off to a flat opening on Monday owing to a dismal show by petro major Reliance Industries followed by a slump in Hindustan Unilever’s profit and RBI’s decision to keep the key policy rates unchanged which dragged the SENSEX to 15332 marginally down by 43 points. On Wednesday, heavy selling in Pivotals pulled the indices down 158 points with Tata Steel, Sterlite , DLF, Tata Motors and Sun Pharma being among the top losers. There was a turn-around on Thursday where-in Short covering on the expiry of FIN-NICHE August 2, 2009 the July series contract, buying by domestic institutions towards the fag end of the session and better-than expected earnings by State Bank of India aided the indices to recover smartly. Continuing with Thursday’s momentum The Indian markets witnessed a smart rally on Friday, marking a day of volatile session with the SENSEX closing with a gain of 282 points at 15.670 after touching an intra-day high of 15,732. Good results by Corporate and buying by FIIs and domestic institutions seem to have triggered the rally. Macro Economy In a major event, the Rererve Bank of India (RBI) kept the key rates unchanged and increased the inflation forecast to 5% by end March 2010 from earlier 4%, at its quarterly monetary policy review meet on Tuesday, 28 July 2009. The central bank raised its inflation forecast, saying an uncertain outlook for monsoon rains could "accentuate" inflation for already-high food prices. The repo rate, at which the central bank lends cash to banks, stays at 4.75%, and the reverse repo rate, at which it absorbs surplus cash from the banking system, stays at 3.25%. Both these rates are at record low level. The statutory liquidity ratio (SLR) was also kept unchanged at 24%. The RBI also kept the cash reserve ratio (CRR), the amount of funds banks have to keep on deposit with it, unchanged at 5%. The RBI said GDP is expected to grow at 6% in FY 2010, with an upward bias. At the time of the annual monetary policy announcement in April 2009, the central bank had forecast a 6% growth. So, the words 'upward bias' was the addition to that forecast. Indian rupee emerged stronger compared to the USD and was trading at an exchange rate of Rs 47.94/ USD. The gold price corrected a bit from its earlier weekly close and was quoted at Rs 14680 per 10 grams. Sectoral Performance FMCG and IT were the strongest performers owing to the strong quarter results. FMCG sector grew by 6.14 % whereas IT grew by 4.85 % over the previous week. The worst performers were Oil & Gas, Pharma and Consumer Durables, all ending in red with Pharma losing the most i.e. 1.58% over the previous week. FIN-NICHE August 2, 2009 BSE Indices this week (% Change) 7 6.14 6 4.85 5 4 3.12 3.04 3.14 3 2.29 2.2 2.31 2.04 1.57 2 1 0.14 0 -1 -0.64 -2 -1.2 -1.58 Global Cues As for other global markets, they witnessed a good week as well, with all recording gains on a week on week basis. Leading the pack was the US Market. The Wall Street was on fire turning up the summer heat with the Dow and S&P now on pace for their best July in twenty and twelve years respectively. For the month (as of the close today), the Dow was up 8.6%, the S&P was up 7.4%, and the Nasdaq was up 7.8%. The European market saw some correction on the last trading session for the week with the indices falling by around 0.50%. The Asian markets were on a high with Hang Seng and Nikkei 225 gaining 1.68% and 1.89% respectively to end the month on a positive note. An ETIG study of 850 listed companies saw their net profits rising 13% over the year-ago period after three dismal quarters, helped by falling raw material costs, lower cost of borrowing and modest growth in wage bills. The study did not include banks and public sector oil companies as their fortunes are directly linked to government policies. FIN-NICHE August 2, 2009 World Markets this Week (% Change) 5 4.73 4.5 3.98 4 3.5 2.87 3 2.5 1.93 1.86 1.75 2 1.5 1.16 0.83 0.69 1 0.56 0.5 0 FIN-NICHE August 2, 2009 NEWS THIS WEEK 1. SOARING PPOs—augurs well for B schools There are signs of green shoots at India’s top-notch B-school campuses, as the placement season is turning positive again. The second half of 2009 is not as solemn an affair as the first half, which witnessed a prolonged placement process, and more realistic salary offers. 2. Mahindra Satyam loses Railways’ tech contract Indian Railways has cancelled a locomotive management system (LMS) contract awarded to Satyam Computer Services (now Mahindra Satyam) in January this year, after the company failed to meet the deadline for submitting required financial details and start working on the pilot project. 3. Stimulus shot: China back on growth track, but US staggers It is a tale of two economies, China and the United States. The United States, the world’s largest economy, remains mired in recession as do most of its fellow top industrial powers. China, meanwhile, has returned to growth. Economic and strategic cooperation between the two world economic superpowers tops the agenda as top officials from both countries hold a two-day meeting in Washington, beginning Monday. 4. Tata Motors net races 58% despite sales dip Tata Motors, whose portfolio stretches from the marque Jaguar to the world’s cheapest car Nano, defied market forecasts to clock a 58% rise in net profit for the June quarter, on the back of share sales in a sister concern and new accounting norms that offset forex losses. 5. RBS yet to take a call on ABN’s $500-m outsourcing contracts Top outsourcing firms including TCS, Infosys and Patni Computer wait for more clarity at RBS-owned ABN Amro, as the management remains undecided about outsourcing deals worth $400-500 million signed by the erstwhile Dutch bank four years ago with these vendors. In April 2005, ABN Amro had announced several contracts worth nearly $2.5 billion, due to be renewed in 2010. While IBM had won the lion’s share of the deal (around $2 billion) for FIN-NICHE August 2, 2009 managing the bank’s servers, desktops and other IT infrastructure, Accenture, TCS, Infosys and Patni shared $400-500 million worth of contracts for software application, development and maintenance. 6. China to India – tit for tat China, India’s biggest trading partner, has threatened to impose restrictions on imports of food products such as seafood and sesame oil from the country if New Delhi doesn’t scrap its ban on Chinese milk and milk products. Recently, Beijing had locked horns with India over a partial ban. 7. RBI sights green shoots. In its most optimistic prognosis for the economy in 2009, the Reserve Bank of India (RBI) said overall business sentiment was slated for a sharp improvement from its nadir in the April-June 2009 quarter. The central bank also did not sound all that concerned about inflation, explaining an inevitable rise later this year to the waning base effect. 8. Delphi to ride out of bankruptcy Delphi said it has agreed to a deal to sell its assets to creditors, clearing the way for an exit from Chapter 11 bankruptcy protection. The deal has the backing of the auto parts maker’s former parent, General Motors. 9. US home prices rise for first time in 3 yrs US single-family home prices rose in May from April, the first monthly increase in nearly three years, suggesting prices may be stabilizing, according to Standard & Poor’s/Case Shiller home price indexes on Tuesday. The annual rate of decline for the 10 and 20-city indexes improved for the fourth straight month, though prices have still tumbled by more than 32% from the peaks in the second quarter of 2006. 10. Bharti-MTN merger (if at all), in Sept The deal between Bharti Airtel and South African telco MTN is likely to be inked by September this year. It is learnt that the two companies could extend the exclusivity period for discussion by a few weeks. The original timeline for discussions expires on July 31. In the FIN-NICHE August 2, 2009 event of the deal going through, the Bharti-MTN combined entity will be the third-largest wireless group globally. 11. INDIA INC, What a start in Q1!! India Inc has begun the new financial year on a pleasant note, with four out of five companies making profits in the first quarter. Analysts see better earnings for the rest of the year on falling cost of operations. FIN-NICHE August 2, 2009 TERMS 1. Bundling The practice of joining related products together for the purpose of selling them as a single unit. This is generally carried out when the seller thinks that the characteristics of two or more products and services are such that these products might appeal to many consumers more as a package than as individual offerings e.g. local and long distance services. Bundling arrangements usually feature a special pricing arrangements which make it cheaper to buy the products and services as a bundle than separately. Bundling is also often a way for creating a larger market for relatively low value products by selling them cheap (or giving them away free) with a higher value product e.g. giving away free floppy disks with the purchase of high-end computer software. The floppies might be an incentive to buy that particular software, and quite possibly the software price has a slight mark-up in it to cover the cost of the floppies. 2. ESOP Employee Stock Ownership Plan (ESOP) is a trust established by a corporate which acts as a tax-qualified, defined-contribution retirement plan by making the corporation's employees partial owners. contributions are made by the sponsoring employer, and can grow tax- deferred, just as with an IRA or 401(k). But unlike other retirement plans, the contributions must be invested in the company's stock. The benefits for the company include increased cash flow, tax savings, and increased productivity from highly motivated workers. The main benefit for the employees is the ability to share in the company's success. Due to the tax benefits, the administration of ESOPs is regulated, and numerous restrictions apply. It is also called stock purchase plan. 3. Yen carry trade It is a specific example of a currency carry trade, where an investor will exchange a specific amount of Japanese Yen for another currency with a higher interest rate, and then will invest the new currency in hopes of earning more interest than could have been earned with the yen. 4. Credit union FIN-NICHE August 2, 2009 It is a non-profit financial institution that is owned and operated entirely by its members. Credit unions provide financial services for their members, including savings and lending. Large organizations and companies may organize credit unions for their members and employees, respectively. To join a credit union, a person must ordinarily belong to a participating organization, such as a college alumni association or labour union. When a person deposits money in a credit union, he/she becomes a member of the union because the deposit is considered partial ownership in the credit union. 5. Relative strength It is defined as the stock's price change over a period of time relative to that of a market index, such as the S&P 500. The relative strength of a stock is calculated by taking the percentage price change of a stock over a set period of time and ranking it on a scale of 1 to 100 against all other stocks on the market, with 1 being worst and 100 being best. For example, a stock with a relative strength of 90 has experienced a greater increase in its price over the last year than the price increases experienced by 90% of all other stocks on the market. Some technical analysts, especially momentum investors, like stocks with high relative strength rankings, believing that stocks which have recently gone up are more likely to continue going up. Other technical analysts believe that a very high relative strength can be an indication that the stock is overbought and is ready to fall. Relative strength is really a "rear view mirror" metric, measuring only how the stock has done in the past, not how it will do in the future.
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