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					       The Global Economic                                               ICRABULLETIN

                                                                         Money
       Environment and the Indian                                               &
       Financial Markets                                                        Finance
                                                                               JULY–DEC..0 4




                                         List of Acronyms

AMFI        : Association of Mutual Funds          IIP      : Index of Industrial Production
              in India                             IMF      : International Monetary Fund
BoE         : Bank of England                      ISM      : Institute for Supply Manage-
BoP         : Balance of Payments                             ment
BSE         : Bombay (Mumbai) Stock                LAF      : Liquidity Adjustment Facility
              Exchange                             LSE      : London Stock Exchange
CBDT        : Central Board of Direct Taxes        MBA      : Mortgage Bankers Association
CFNAI       : Chicago Fed National Activity        MF       : Mutual Fund
              Index                                MPC      : Monetary Policy Committee
CMIE        : Centre for Monitoring Indian         MSB      : Market Stabilisation Bonds
              Economy                              MSS      : Market Stabilisation Scheme
CMR         : Call Money Rate                      NSE      : National Stock Exchange
CPI         : Consumer Price Index                 NTPC     : National Thermal Power
CRR         : Cash Reserve Ratio                              Corporation
ECB         : European Central Bank                OMO      : Open Market Operations
EPF         : Employees’ Provident Fund            PCE      : Personal Consumption
Euro zone   : Belgium, Germany, Greece, Spain,                Expenditures
              France, Ireland, Italy, Luxem-       PDI      : Personal Disposable Income
              bourg, the Netherlands, Austria,     PLR      : Prime Lending Rate
              Portugal and Finland                 PMI      : A composite diffusion index
EU25        : Belgium, the Czech Republic,                    used in US ISM’s Manufacturing
              Denmark, Germany, Estonia,                      Report On Business;
              Greece, Spain, France, Ireland,                 Purchasing Manager’s Index
              Italy, Cyprus, Latvia, Lithuania,               (for the Euro zone)
              Luxembourg, Hungary, Malta,          qoq      : quarter on quarter
              the Netherlands, Austria, Poland,    RBI      : Reserve Bank of India
              Portugal, Slovenia, Slovakia,        SA       : Seasonally Adjusted
              Finland, Sweden and the United       SAAR     : Seasonally Adjusted Annual
              Kingdom                                         Rate
FII         : Foreign Institutional Investment     SEBI     : Securities and Exchange Board
FOMC        : Federal Open Market Committee,                  of India
              US                                   STT      : Securities Transaction Tax
GDP         : Gross Domestic Product               WEO      : World Economic Outlook
HICP        : Harmonised Index of Consumer         WPI      : Wholesale Price Index
              Prices                               yoy      : year on year


                                                                                      163
 ICRABULLETIN                    Global Economy
                                  In the second quarter of 2004, growth momentum moderated
  Money
        &
                         throughout the global economy, vis-à-vis the exceptionally fast pace of
                         expansion in the first quarter of the year. The recent volatility and hike
         Finance         in oil prices, driven by a combination of surging demand and supply
                         concerns in several major oil-exporting countries, and to an extent
       JULY–DEC..0 4
                         exacerbated by low excess capacity and speculative activity, have so
                         far had a moderate impact on economic stability. Nevertheless,
                         persistently high and further increasing oil prices could very well
                         repress corporate profits and household real incomes. Financial markets
                         globally are adjusting to the interest rate tightening cycle initiated in
Financial markets
                         the US in June. The resurgence of inflationary pressures, primarily due
globally are             to geopolitical tensions and a high possibility of further oil price rises,
                         has however tempered expectations about the steepening of rates
adjusting to the         globally.

interest rate                      The US
                                   US GDP growth was revised upwards (from an estimated 2.8
tightening cycle         per cent) to 3.3 per cent (SAAR) in the second quarter of 2004; thus the
                         US economy has slowed somewhat from the (revised) 4.5 per cent
initiated in the US in   growth of the first quarter. Consumer spending growth looked quite
                         weak, but other categories of aggregate spending appear to have
June. The                mitigated some of the weakness in the consumer sector. The
                         contributors to the increase in real GDP in the second quarter were non-
resurgence of
                         residential fixed investment, PCE, residential fixed investment, private
inflationary             inventory investment, exports, and government spending; imports,
                         which are a subtraction in the calculation of GDP, increased. Compared
pressures, primarily     to the first quarter, the deceleration in real GDP growth in the second
                         quarter reflected decelerations in PCE and in private inventory
due to geopolitical      investment and an acceleration in imports that was partly offset by
                         accelerations in non-residential fixed investment and in residential fixed
tensions and a high      investment. PCE increased 1.6 per cent in the second quarter, compared
                         with an increase of 4.1 per cent in the first; non-residential fixed
possibility of further   investment increased 12.5 per cent, compared to 4.2 per cent; non-
                         residential structures increased 6.9 per cent, in contrast to a decrease of
oil price rises, has
                         7.6 per cent; equipment and software increased 14.2 per cent, compared
however tempered         with an increase of 8.0 per cent; residential fixed investment increased
                         16.5 per cent, compared with an increase of 5.0 per cent; real exports
expectations about       of goods and services increased 7.3 per cent in the second quarter, the
                         same increase as in the first; while real imports of goods and services
the steepening of        increased 12.6 per cent, compared with an increase of 10.6 per cent.
                         Real federal government consumption expenditures and gross
rates globally.          investment increased 2.7 per cent in the second quarter, compared with
                         an increase of 7.1 per cent in the first. National defence expenditure
                         increased 1.9 per cent, compared with an increase of 10.6 per cent;
                         non-defence expenditure increased 4.4 per cent, compared with an
164                      increase of 0.2 per cent. [Chart G.1.1 shows the contributions of the
                                  CHART G.1.1                                                                                                 ICRABULLETIN
         Contributions to change in US GDP* in 2004 (percentage points)
                                                                                                                                              Money
   3.0
   2.5
                                                                                                                                                    &
   2.0
                                            2004:Q1                   2004:Q2                                                                        Finance
   1.5
                                                                                                                                                    JULY–DEC..0 4
   1.0
   0.5
   0.0
  -0.5
  -1.0
                             s




                                                       s




                                                                                  Private Fixed
                                            Energy goods




                                                                        Housing




                                                                                     investment


                                                                                                  investment


                                                                                                                Net exports




                                                                                                                              & Investment
                 Durable goods




                                                                                                                              Consumption
          PCE




                                  Motor

                                 & parts




                                                           Services




                                                                                                                                      Govt
                                 vehicles




                                                                                                  Residential
                                                                                                                                                Another cause for

                                                                                                                                               concern is that the
* percentage change (SAAR).
                                                                                                                                              financial sector still
various components to the change in US GDP in the second quarter                                                                              accounted for 42%
compared to the first]. Corporate profits from current production (with
inventory valuation and capital consumption adjustments), considered                                                                              of US corporate
as the best measure of industry profits, increased by only $8.3 billion in
the second quarter, after a first quarter increase of $36.5 billion.                                                                            profits in the first
Current-production cash flow (net cash flow with inventory valuation
and capital consumption adjustments), which gives the internal funds                                                                                 half of 2004,
available to corporations for investment, in fact decreased $5.7 billion
                                                                                                                                              compared with just
in the second quarter, in contrast to an increase of $5.9 billion in the
first. Taxes on corporate income increased $14.7 billion in the second                                                                         about 12% for the
quarter, compared with an increase of $4.2 billion in the first. Profits
after tax with inventory valuation and capital consumption adjustments                                                                             manufacturing
decreased $6.4 billion in the second quarter, after increasing $32.3
billion in the first. Profits both before and after tax (without inventory                                                                   sector; this seems to
valuation and capital consumption adjustments) increased in the second
quarter after decreasing slightly in the first. Private businesses increased                                                                 be a clear indication
inventories to the tune of $61.1 billion in the second quarter, following
increases of $40.0 billion in the first quarter and $8.6 billion in the                                                                              of consumer
fourth quarter of 2003 [Chart G.1.2.1]. Another cause for concern is
that the financial sector still accounted for 42 per cent of US corporate
                                                                                                                                              financing excesses.
profits in the first half of 2004, compared with just about 12 per cent
for the manufacturing sector [Chart G.1.2.2]; this seems to be a clear
indication of consumer financing excesses.
         Industrial production rose a disappointing 0.1 per cent in
September, even as the August figure was revised downward to -0.1 per
cent, following an upward revised increase of 0.7 per cent in July. After
decreasing 0.1 per cent in June, manufacturing output gained 0.9 per
cent in July and 0.2 per cent in August, but edged down in September
by -0.3 per cent [Chart G.1.3]. Economic activity in the manufacturing
sector grew in August and September at a slower pace, according to the
ISM, while the CFNAI, though positive, went down sharply to an                                                                                             165
ICRABULLETIN                                        CHART G.1.2.1
                                US Corporate Profits and Taxes (percentage change, qoq)
Money
      &              12.0                                                  Corporate profits*
                                                                           Taxes on corporate income
      Finance        10.0                                                  Profits after tax*
                                                                           Profits before tax**
   JULY–DEC..0 4      8.0                                                  Profits after tax**
                                                                           Net cash flow*
                      6.0

                      4.0

                      2.0

                      0.0

                      -2.0
                                2003:Q3            2003:Q4               2004:Q1            2004:Q2

                   * with inventory valuation and capital consumption consumption adjustments.
                   ** without inventory valuation and capital consumption consumption adjustments.


                                                    CHART G.1.2.2
                             US Corporate Profits in the Financial and Manufacturing sectors


                                  Financial   Non-Financial*     Retail trade      Manufacturing
                      100%
                                  54.1          66.8            93.4             81.5          94.8
                       90%
                                  82.6          78.9            74.7             80.0          73.1
                       80%
                       70%
                       60%       230.1          251.9           252.6            244.9         280.9
                       50%
                       40%
                       30%
                       20%       295.4          306.1           305.3            313.7         306.4
                       10%
                        0%
                                2003:Q2       2003:Q3          2003:Q4          2004:Q1      2004:Q2

                   As percentage of Domestic profits with inventory valuation adjustments (values in
                   billion US$).
                   *excludes manufacturing and retail trade.


                   estimated 0.19 in August, from an upward revised 0.53 in July.
                   August’s CFNAI was revised downwards further to a mere 0.03 and for
                   September the index is estimated at -0.01, showing that growth was
                   below trend for the latest month.
                           The pace of services sector expansion slowed considerably in
                   recent months, as the ISM Non-Manufacturing index tumbled 6.6
                   points down to 58.2 in August and further down to 56.7 in September.
                   The impacts of recent hurricanes pushed up jobless claims for a few
                   weeks but claims for benefits declined again by end-September. The
166                unemployment rate for August stood unchanged at 5.4 per cent, while
                                           CHART G.1.3                                                                                                          ICRABULLETIN
                           US Business and Manufacturing Activity Indicators
                                                                                                                                                                Money
                  Apr-01
                                                                                                                                                                      &

                                                      Apr-02




                                                                                          Apr-03




                                                                                                                              Apr-04
                                    Oct-01




                                                                        Oct-02




                                                                                                            Oct-03
         Jan-01




                                             Jan-02




                                                                                 Jan-03




                                                                                                                     Jan-04
                           Jul-01




                                                               Jul-02




                                                                                                   Jul-03




                                                                                                                                       Jul-04
                                                                                                                                                                       Finance
   1.5                                                                                                                                          65                   JULY–DEC..0 4
    1                                                                                                                                           60
   0.5                                                                                                                                          55




                                                                                                                                                     ISM_PMI
    0                                                                                                                                           50
  -0.5                                                                                                                                          45
    -1                                                                                                                                          40              The balance on the
  -1.5                                                                                                                                          35
                                                                                                                                                                US current account
    -2                                                                                                                                          30
                           IIP Manufacturing growth*                                        CFNAI                     ISM_PMI                                    registered another
* percentage change over previous month.                                                                                                                       sharp decline of $19

wage growth slowed modestly to 0.4 per cent in August from 0.6 per                                                                                                billion during the
cent in the previous month. PDI rose 0.4 per cent in August, after a
weak 0.2 per cent growth the prior two months, while PCE increased by                                                                                          second quarter, after
a very weak 0.1 per cent after a strong 1.1 per cent growth in July
compared to a negative in June. Farm prices fell 5 per cent in                                                                                                 a $20 billion decline
September, as the composite price indexes for crops and livestock
                                                                                                                                                                during the first. An
products dropped 5.9 per cent and 4.1 per cent, respectively. Despite
higher energy prices, PPI for finished goods fell by 0.1 per cent in                                                                                                 increase in the
August; excluding food and energy, core prices for both crude and
intermediate goods rose sharply. In September, PPI for finished goods                                                                                                 goods deficit
increased by 0.1 per cent, and would been larger if not for a 0.9 per
cent decline in the finished energy goods index. Rapid inflation                                                                                                 pushed the overall
continued among core intermediate goods, which increased for the 14th
consecutive month in September. CPI rose 0.2 per cent in September,                                                                                             balance to -$166.2
while core consumer prices rose 0.3 per cent, taking core inflation to
2.0 per cent, for the first time in almost two years. The MBA index of                                                                                                      billion.
housing finance activity after an increase in late September, fell back
sharply in early October, with both the refinance and purchase indices
registering losses despite decline in mortgage interest rates; both have
however, reversed to strength in mid-October.
         The balance on the US current account registered another sharp
decline of $19 billion during the second quarter, after a $20 billion
decline during the first. An increase in the goods deficit pushed the
overall balance to -$166.2 billion. High oil prices and a plunge in
exports of capital goods during June drove the larger goods deficit. Oil
imports pushed the US trade balance deeper into the red during August,
as exports increased marginally, and imports rose further to push the
balance of trade to -$54.0 billion. Import prices rose a smaller than
expected 0.2 per cent in September, following a revised 1.4 per cent                                                                                                        167
 ICRABULLETIN          increase in August.1 Petroleum prices rose just 0.6 per cent for
                       September, increasing the likelihood of a larger increase next month,
  Money
           &
                       given the surge in crude prices in early October. Export prices rose
                       0.4 per cent on the strength of a 1.6 per cent increase in agricultural
           Finance     export prices, while in August, export prices had fallen 0.5 per cent as
                       a sharp decline in agricultural commodity prices had more than offset
       JULY–DEC..0 4
                       the 0.4 per cent increase in other export prices. The trade weighted
                       value of the US dollar rose further through September and early
                       October despite indications of a weak US economy. Till date the US
                       Government is continuing to add to its Strategic Petroleum Reserve,
                       rather than depleting it in order to intervene and reduce oil prices.
Fiscal policy is
                                The unified Treasury budget surplus for September, the last
likely to be mildly    month of the current fiscal, was $24 billion, after a $41 billion deficit
                       in August. For the full fiscal year 2004, the federal government ran a
restrictive over the   deficit of $413 billion, a new record in nominal dollar terms. The
                       FOMC unanimously decided to raise its overnight federal funds target
next few years,        by 25 basis points on September 21, to 1.75 per cent as widely
                       expected. The Fed continues to see the risks facing its growth and
while at the same      inflation outlooks as balanced and reaffirmed its expectation that the
                       current accommodative stance of monetary policy can be removed at a
time higher interest   measured pace. Fiscal policy is likely to be mildly restrictive over the
                       next few years, while at the same time higher interest rates and oil
rates and oil prices   prices are giving rise to some pessimism regarding US consumer
                       spending,2 so far a dominant contributor to the global economic
are giving rise to
                       revival.
some pessimism
                                 Euro Area
regarding US                     The euro area experienced moderate growth during the second
                       quarter of 2004, with real GDP advancing by 0.5 per cent (qoq, SA),
consumer spending,     slightly slower than the first quarter turnout of 0.6 per cent. The quality
                       of growth remained doubtful, with private consumption slowing down
so far a dominant      and business demand still very soft. Both exports and imports however
                       accelerated. During the second quarter, household final consumption
contributor to the     expenditure grew by 0.3 per cent (after a 0.6 per cent growth in the first
                       quarter) [Charts G.2.1-G.2.3]; however, government consumption
global economic
                       increased by 0.6 per cent (compared to 0.1 per cent); investments
revival.               increased by 0.1 per cent (compared to -0.2 per cent); exports rose by
                       3.7 per cent (compared to 1.4 per cent); and imports by 2.9 per cent
                       (compared to 0.3 per cent in the first quarter). Both industry and the




                                  1 In August, excluding petroleum products, import prices rose 0.4 per cent,

                       which was the largest increase since February.
                                  2 Home price to rent ratio is also expected to come down in line with

                       historical averages either through a sharp correction or through a period of
                       stagnation in home prices. If it does happen, it might induce the typical American
168                    household to think of saving more, thus reducing consumption.
                                                  CHART G.2.1                                                                                         ICRABULLETIN
                                         Private consumption expenditure
                                  (percentage change over the previous quarter*)                                                                      Money
                                                                                                                                                             &
 1.5
                                                                                                                                         Euro-zone           Finance
   1
                                                                                                                                         EU25               JULY–DEC..0 4
 0.5
                                                                                                                                         Germany
   0
                                                                                                                                         France
 -0.5
                                                                                                                                         United
   -1                                                                                                                                    Kingdom       Growth in the euro



                                                                                                        2002:Q2

                                                                                                                   2002:Q1

                                                                                                                              2001:Q4
           2004:Q2

                     2004:Q1

                                  2003:Q4

                                             2003:Q3

                                                           2003:Q2

                                                                     2003:Q1

                                                                                  2002:Q4

                                                                                             2002:Q3
                                                                                                                                                      zone service sector

                                                                                                                                                      slowed modestly in
                                                  CHART G.2.2
                                       Government consumption expenditure                                                                               August with euro
                                  (percentage change over the previous quarter*)
                                                                                                                                                       zone Services PMI
  2.5                                                                                                                                                dipping to 54.5 from
    2
  1.5
    1                                                                                                                                                    55.3 in July; the
  0.5
                                                                                                                                         Euro-
    0
                                                                                                                                         zone        index fell further to a
 -0.5                                                                                                                                    EU25
   -1
 -1.5                                                                                                                                    Germany         13-month low of
        2004:Q2



                               2003:Q4



                                                       2003:Q2




                                                                               2002:Q4




                                                                                                        2002:Q2



                                                                                                                              2001:Q4




                                                                                                                                         France       53.3 in September,
                                                                                                                                         United
                                                                                                                                                      though it remained
                                                   CHART G.2.3                                                                                           above the key 50
                                            Gross fixed capital formation
                                   (percentage change over the previous quarter*)
                                                                                                                                                      watermark between
 3.0                                                                                                                                                      contraction and
 2.0
 1.0
                                                                                                                                                                   growth.
                                                                                                                                         Euro-zone
 0.0
                                                                                                                                         EU25
 -1.0
 -2.0                                                                                                                                    Germany

 -3.0                                                                                                                                    France
                                                                                                         2002:Q2

                                                                                                                    2002:Q1

                                                                                                                               2001:Q4
           2004:Q2

                     2004:Q1

                                   2003:Q4

                                             2003:Q3

                                                           2003:Q2

                                                                     2003:Q1

                                                                                   2002:Q4

                                                                                              2002:Q3




                                                                                                                                         United



* from SA values in constant prices.                                                                                                                               169
 ICRABULLETIN           services sector trended up in the second quarter as gross value added in
                        industry grew by 1.1 per cent; financial services and business activities
  Money
         &
                        rose by 0.8 per cent; trade, transport and communications services
                        grew by 0.6 per cent; and construction expanded by 0.5 per cent. EU25
          Finance       GDP grew by 0.6 per cent in the second quarter of 2004 after 0.7 per
                        cent growth in the first quarter; household final consumption
       JULY–DEC..0 4
                        expenditure grew by 0.6 per cent; investments increased by 0.4 per cent
                        (compared to 0.1 per cent in the first quarter); exports rose by 3.5 per
                        cent (compared to 1.1 per cent); and imports by 2.8 per cent (after 0.2
                        per cent growth in the first). Construction activities decelerated, while
                        gross value added in industry; financial services and business activities;
In September euro-
                        trade, transport and communications services expanded significantly.
zone HICP inflation               The euro zone industrial sector started off the third quarter on
                        a stronger note as activity rose in July by 0.4 per cent (SA) compared to
cooled for a third      June 2004, matching expectations and more than reversing a 0.2 per
                        cent contraction reported in June. Consumer goods notched by far the
successive month,       largest increase, though in part that is a reflection of June’s
                        considerable weakness. Output in the EU25 grew by 0.2 per cent in July
rising 0.2% in the      2004, after a fall of 0.1 per cent in June. However, industrial
                        production decreased 0.6 per cent (SA) in August from July, with both
month and only          utilities, as well as finished goods showing declines. Growth in the euro
                        zone service sector slowed modestly in August with euro zone Services
2.1% in the year. On    PMI dipping to 54.5 from 55.3 in July; the index fell further to a 13-
                        month low of 53.3 in September, though it remained above the key 50
the basis of current
                        watermark between contraction and growth. National indices for
market expectations     Germany and France slipped to 13-month lows of 52.1 and 53.1,
                        respectively and growth also slowed in the UK, Italy, Ireland and
for oil prices, it      Spain. The manufacturing index for September also dipped to a seven-
                        month low of 53.1.
appears unlikely that             The balance on the current account for the euro area
                        deteriorated for the fourth consecutive month in August from a 2.1
annual inflation        billion euro (SA) surplus in June to a 1.0 billion euro surplus in July
                        and to a marginal deficit of 400 million euros in August. This resulted
rates will return to    from a decrease in the surplus of goods (by 3.7 billion euros), partially
                        counterbalanced by a rise in the services surplus (by 1.1 billion euro)
levels below 2% in
                        and a reduction in the deficits in both income (by 0.4 billion euros) and
the remainder of        current transfers (by 0.8 billion euros). In the financial account,
                        combined direct investment and portfolio investment recorded net
this year.              inflows that predominantly reflected the repayment of inter-company
                        loans by foreign affiliates of euro area companies and net inflows in
                        portfolio equity securities. The EU25 external current account recorded
                        a deficit of 3.0 billion euros in the second quarter of 2004, as compared
                        with a deficit of 3.8 billion euros in the first quarter of 2004. In the
                        second quarter of 2004, compared to the second quarter of 2003, a
                        higher surplus was recorded in the services account (14.3 billion euros
                        compared to 11.7 billion), and a smaller deficit for goods (-0.9 billion
170                     compared to -2.4 billion), while the income (-8.3 billion compared to
-6.9 billion) and current transfers accounts (-8.1 billion compared to       ICRABULLETIN

-7.7 billion) registered higher deficits.
                                                                              Money
          Euro-zone and EU25 unemployment stood at 9.0 per cent (SA)
in August 2004, unchanged from July. Recent oil price developments                 &
have had a visible direct impact on price developments in the euro                  Finance
area. The euro-zone PPI for industrial products rose by 0.4 per cent in
                                                                                   JULY–DEC..0 4
August 2004 over July, and by 0.5 per cent in the EU25 nations. In July
PPI had increased by 0.5 per cent in the euro-zone and by 0.4 per cent
in the EU25. Monthly inflation in August inched up over July by 0.2
per cent, so that annual HICP inflation, stood at 2.3 per cent,
unchanged from July. In September euro-zone HICP inflation cooled for
                                                                                In Japan, growth
a third successive month, rising 0.2 per cent in the month and only 2.1
per cent in the year. On the basis of current market expectations for oil          slowed in the
prices, it appears unlikely that annual inflation rates will return to
levels below 2 per cent in the remainder of this year. The ECB held            second quarter of
monetary policy constant in October, keeping the minimum bid rate on
main refinancing operations (the repo rate), which is the central bank’s        2004, though the
main policy instrument, constant at 2.0 per cent.
          Industrial production in Europe’s largest economy rebounded in      underlying growth
July expanding by 1.6 per cent over June, but declined again in August
by 1.0 per cent, though growth remained strong compared to one year                momentum is
ago. The German unemployment rate however, stood at 10.6 per cent
inching up from 10.5 per cent in July; taking into account the ongoing
                                                                             judged to be robust.
decrease in payroll employment numbers, these data underline the grim
                                                                             GDP grew by 0.4%
condition of Germany’s labour market despite the largely export-led
recovery. The French industrial sector contracted sharply as industrial            (qoq), after an
activity slid 1.9 per cent (SA) in August from July; the setback was led
by a mammoth 14.4 per cent drop in automotive activity. French               upward revised rate
Consumer price inflation accelerated modestly, rising a 0.3 per cent
(SA) in August over July; in September CPI growth moderated, rising           of 1.6% in the first
0.2 per cent, mirroring trends across much of the euro zone. The French
unemployment rate once again seesawed in August and rose to 9.9 per                  quarter. The
cent, reversing July’s small improvement. Italy got off to a promising
start in the third quarter, with industrial production rising 0.4 per cent     decomposition of
in July over June, the best growth in three months; however industrial
                                                                             GDP figures shows
production reversed course and fell 0.8 per cent in August. Industrial
production in Portugal slumped in August, falling 1.9 per cent over the              that external
previous month, eclipsing July’s fall of 1.7 per cent.
          In the UK, activity remained robust in the second quarter, as      demand remains an
despite higher oil prices, private consumption remained strong,
underpinned by sustained income growth and rising housing wealth;              important driving
private investment has firmed up, and government expenditures have
continued to support domestic demand. In the third quarter, UK growth                      factor.
has been pulled back with GDP advancing by 0.4 per cent (qoq, SA), as
service activity remained strong, but manufacturing output displayed a
sharp contraction. The UK labour market which remained firm in July
and August, continued to tighten as joblessness both by claimant count                    171
 ICRABULLETIN            (for September) and by ILO standards (through August) fell, while job
                         vacancies continued to rise. The central risk remains an abrupt
  Money
        &
                         adjustment in the housing market, where prices still appear higher than
                         can be explained by economic fundamentals. Housing prices rose at a
         Finance         subdued rate for a second consecutive month in September—the index
                         rose only 0.2 per cent over August triggering a further cooling in the
       JULY–DEC..0 4
                         annual housing price inflation rate to 17.8 per cent from 18.9 per cent
                         in August. EU-harmonised CPI inflation rose 0.3 per cent in August
                         over July, fully reversing July’s monthly decline. In line with easing of
                         housing prices and slowing of the services sector, the MPC of the BoE
                         held its benchmark repo rate at 4.75 per cent in October too; the MPC
In China the fear of a
                         had earlier raised rates by 25 per cent in August.
hard landing has so                In Sweden output rose 2.9 per cent (SA) in August over July,
                         regaining some of the ground lost in June and July, when output had
far been refuted, as     dipped 2.2 per cent and 2.1 per cent, respectively. As was widely
                         anticipated, the Swedish monetary authorities left their benchmark
there have been          policy rate unchanged at a historically low 2.0 per cent in October.
                         Underpinning the decision to hold were the central bank’s forecasts of
changes in policy to     moderate inflation despite high oil prices, a strengthening recovery, and
                         rising capacity utilisation. Polish real GDP grew 6.1 per cent (yoy) in
soften the economic      the second quarter; however, investment spending disappointed, slowing
                         from 3.5 per cent in the first quarter to 3.3 per cent in the second. For
landing, but not an      the first time in four monetary policy council meetings, the National
                         Bank of Poland did not elect to increase interest rates from 6.50 per
entire reversal.
                         cent, in September and held rates steady in October too. The central
Despite decelerating     bank did, however, maintain its restrictive stance, suggesting that
                         further hikes may be coming. In Hungary, second quarter GDP grew
bank credit, China       4 per cent (yoy); components of growth have shifted from domestic
                         consumption to investments and exports. Industrial production grew a
still sees strong        very disappointing 3.9 per cent in August with the industrial sector
                         slowing much faster than expected; hence the National Bank’s policy
industrial               rate, which was left unchanged at 11 per cent in September, was cut by
                         50 basis points in October. The Czech economy expanded by 4.1 per
production, retail       cent (yoy) in the second quarter of 2004, while the first quarter growth
                         estimate of 3.1 per cent was revised higher to 3.5 per cent. Surging
sales, trade, and
                         business investment is responsible for the acceleration in overall
investment, while        growth. Industrial output adjusted for work days expanded 1.4 per cent
                         from June to July, and increased 18.0 per cent (yoy), this being the fifth
inflation pressure is    consecutive month of double-digit growth. Production however recorded
                         the slowest pace of growth in six months at 6.5 per cent (yoy) in
still around.            August. In end-September and October, all monetary policy instruments
                         were left unchanged.

                                  Asia
                                  In Japan, growth slowed in the second quarter of 2004, though
                         the underlying growth momentum is judged to be robust. GDP grew by
172                      0.4 per cent (qoq), after an upward revised rate of 1.6 per cent in the
first quarter. The decomposition of GDP figures shows that external           ICRABULLETIN

demand remains an important driving factor; exports increased by 3.5
                                                                              Money
per cent, with the relative growth contributions of exports to Europe,
Asia and the US becoming more balanced. Import growth slowed                        &
somewhat resulting in a net trade contribution of 0.3 percentage point.             Finance
In the domestic economy, private consumption growth remained robust
                                                                                   JULY–DEC..0 4
at 0.6 per cent, reflecting improvements in the labour market and
disposable income. Private non-residential investment spending, earlier
an important driver of growth was flat in the second quarter, despite
rising machinery orders and robust corporate profits. The decline in
                                                                                  Questions have
public investment accelerated as fiscal consolidation continues. The
                                                                                 arisen about the
GDP deflator continues to indicate more pronounced deflationary
pressures, declining by 2.6 per cent (yoy) in the second quarter. The rise           Chinese real
in commodities and intermediate goods prices has resulted in corporate
goods prices (former wholesale prices) rising by 1.6 per cent (yoy) in       unemployment rate;
July. Bank of Japan decided to maintain its pre-existing monetary
policy settings and keep its target for the outstanding balance on the             the published
current accounts held at the bank at 30-35 trillion yens; the quantitative
easing strategies will possibly remain until consistent inflation is               numbers only
observed.
         In China the fear of a hard landing has so far been refuted, as       include those who
there have been changes in policy to soften the economic landing, but
                                                                                     are officially
not an entire reversal. Despite decelerating bank credit, China still sees
strong industrial production, retail sales, trade, and investment, while            registered as
inflation pressure is still around. In the second quarter economic
activity continued to expand rapidly, although it has decelerated                 unemployed in
somewhat from the pace reached in the first quarter, largely due to
tightening policies targeted at selected overheated sectors. Industrial       urban areas and do
production rose by 15.5 per cent (yoy) in July, led by exports and fixed
asset investment which rose by 33 per cent and 31 per cent,                     not include those
respectively. In July, annual CPI inflation reached 5.3 per cent, driven
by surging food and housing prices. China’s third quarter GDP is               who are being laid
estimated to have expanded at 9.1 per cent (yoy), marking the third
consecutive quarter of slower growth as breakneck investment and
                                                                             off from state-owned
lending were reined in. However, there were no indications on any
                                                                                     enterprises.
plans to scale back credit and investment curbs, which have helped to
slow the pace of annual growth in GDP from 9.8 per cent in the first          Considerable inter-
quarter and 9.6 per cent in the second quarter. Questions have arisen
about the Chinese real unemployment rate; the published numbers only          regional disparities
include those who are officially registered as unemployed in urban
areas and do not include those who are being laid off from state-owned       also show up in the
enterprises. Considerable inter-regional disparities also show up in the
employment statistics. In South Korea, the expansion in economic                     employment
activity has overall been rather strong, with industrial production
trending higher by 12.8 per cent (yoy) in July [Chart G.3]. This                        statistics.
favourable outcome, however, remains driven by rapid export growth,
while domestic demand continues to be subdued. South Korean                               173
 ICRABULLETIN                                              CHART G.3
                                           Industrial Activity in South Korea in 2004
 Money
          &                     Q1 2004     Q 2 2004         June        July           Aug.
          Finance       5.0                                                                          82.0
                        4.0                                                                          81.5




                                                                                                            Capacity Utilisation Ratio
      JULY–DEC..0 4                                                                                  81.0
                        3.0
                                                                                                     80.5
                        2.0                                                                          80.0
                        1.0                                                                          79.5
                        0.0                                                                          79.0
                                                                                                     78.5
                        -1.0
                                                                                                     78.0
                        -2.0                                                                         77.5
                        -3.0                                                                         77.0
                               AverageCapacity Utilisation Ratio (%)   Industrial Production Index
                               Producer's Shipment Index               Wholesale & Retail Trade

Singapore’s           SA percentage change over the previous Month /Quarter.

manufacturing
                      consumption slumped in July by 3.0 per cent over June, and 0.4 per
output rose only      cent in August, after having gained by 4.4 per cent in June. Orders for
                      domestic machinery sharply reversed trend from the increases of 19.0
5.3% (yoy) in         per cent and 18.1 per cent in May and June, respectively, to a 12.4 per
                      cent decline in July and a 23.3 per cent decline in August. Construction
August, chasing       investment however continued its upward trend, with the value of
                      construction works increasing by 9.9 per cent (yoy) in July after an 8.1
growth of 19.1% in    per cent increase in June and by 8.9 per cent in August. Manufacturing
                      production continued to be favourable, with a high growth of 13.2 per
July; however,        cent (yoy) in July and 10.7 per cent in August; on the contrary, service
                      sector activities remained lacklustre in July and August, contracting by
output grew 11.8%
                      1.4 per cent (yoy) and 1.7 per cent, respectively, compared to the 0.8
(yoy) in September,   per cent gain in June. Unemployment rose in July, to 3.6 per cent and
                      CPI inflation rose by 0.6 per cent in July over June and by 0.9 per cent
recovering from the   in August. Both employment and consumer prices remained stagnant in
                      August and September, respectively. Exports remained buoyant,
weak showing in       increasing by 28.8 per cent (yoy) in August and 23.5 per cent in
                      September, after expanding by 36.3 per cent in July. In August, the
August.               Bank of Korea decided to lower its policy interest rate from 3.75 per
                      cent to an all-time low of 3.5 per cent. Thailand’s economy expanded
                      at a moderate pace during the second quarter, gaining only 0.8 per cent
                      over the first. Slower global growth, high oil prices, new outbreaks of
                      the bird flu and ongoing tensions in the country’s south worked to
                      dampen gains. Thai industrial production in July advanced 9.4 per cent
                      (yoy), following gains of 9.2 per cent in June. Strong regional demand
                      and ongoing strength in Chinese imports of Thai output continued to
                      buoy gains and domestic consumption also promoted July’s output
                      expansion. Thailand’s industrial production slipped in August,
174                   expanding 8.9 (yoy); lower electronic and electrical product output was
the likely cause of August’s weaker output data. Higher oil prices may       ICRABULLETIN

weigh on industrial production over the coming months. Bank of
                                                                             Money
Thailand has raised the 14-day repo rate for the second time in a year
in October, by 25 basis points, and it is now at 1.75 per cent.                    &
Indonesian industrial output slipped 2.4 per cent (yoy) in August; a                Finance
slight improvement from the declines of 4.6 per cent and 4.9 per cent in
                                                                                  JULY–DEC..0 4
July and June, respectively. Singapore’s manufacturing output rose only
5.3 per cent (yoy) in August, chasing growth of 19.1 per cent in July;
however, output grew 11.8 per cent (yoy) in September, recovering from
the weak showing in August. Taiwan’s industrial output rose by 8.8 per
cent (yoy) in August, down from 9.2 per cent growth in July; the pace
                                                                                Brazilian output
of growth slowed further in September to 8.1 per cent. Industrial output
in the Philippines slipped 0.2 per cent (yoy) in July and fell sharply by       showed another
5.0 per cent in August.
                                                                                  strong gain in
         Latin America and Other Countries
         In Latin America, industrial output has picked up across                August as total
countries. Mexican industrial production continues to rise, with July’s
output levels increasing by 3.8 per cent (yoy). Mexican inflation              output increased
accelerated once again in August, as CPI rose a higher than expected
0.62 per cent in August, creating annual inflation of 4.8 per cent.              1.1% in August
Mexican inflation showed no sign of slowing in September as CPI
inflation was up 0.82 per cent and annual inflation rose 5.1 per cent
                                                                                  from July with
(yoy). Mexican unemployment fell to 4.0 per cent in September, from
                                                                              strong production
4.3 per cent in August; it still remains higher than the 3.9 per cent of
September last year. The Brazilian economy is on an upward trend as            across the board,
output increased 0.5 per cent (SA) in July over June. Production of
capital and consumer goods declined, while output of intermediate           and output of capital
materials showed a large increase. Brazilian output showed another
strong gain in August as total output increased 1.1 per cent in August       equipment rallying
from July with strong production across the board, and output of
capital equipment rallying from last month’s decline. Consumer-price           from last month’s
inflation in Brazil slackened to 6.7 per cent in the year to September.
The unemployment rate ticked up in Brazil during August to 11.4 per          decline. Consumer-
cent from 11.2 per cent earlier and average wages also fell in the
                                                                                price inflation in
month. September yielded employment and income gains for Brazilian
workers, as the unemployment rate fell to 10.9 per cent. In Chile            Brazil slackened to
manufacturing activity surged during August, with the country’s
industrial production index up 9.0 per cent, with broad-based gains          6.7% in the year to
across most segments of the industrial base. High energy prices have
not dampened manufacturing activity in Chile. In September, industrial               September.
production in the country jumped 12.0 per cent (yoy), registering the
largest monthly expansion this year. In early September in an
aggressive move, the Central Bank of Chile had raised its monetary
policy instrument by 25 basis points, pushing the Nominal Interbank
Rate to 2.00 per cent. In Venezuela industrial production continued its
return to normalisation in July at a slow pace, as output increased by                    175
 ICRABULLETIN           27.2 per cent (yoy), but mainly due to base effects. Argentine industrial
                        output expanded in September by 10.7 per cent (yoy), completing the
  Money
        &
                        third quarter with a 2 per cent (qoq) increase.
                                 The Turkish economy remains on an above-trend growth
          Finance       trajectory with real GDP growing by 19.9 per cent (SAAR) in the first
                        quarter of 2004. The incoming economic data confirm even stronger
       JULY–DEC..0 4
                        growth performance in the remainder of the year; the industrial
                        production index, for example, rose by 15.9 per cent in the second
                        quarter, up from an average of 11.3 per cent in the previous period.
                        Industrial production in Turkey continued to expand strongly in July,
                        up 12.8 per cent (yoy). Monthly CPI inflation in September was 0.94
Despite steps
                        per cent and WPI inflation at 1.85 per cent, pushing annual CPI
towards                 inflation to 9 per cent (yoy) and WPI inflation to 12.5 per cent.
                        Turkey’s credit ratings for foreign currency debt were raised by
liberalisation, there   Standard & Poor’s and Moody’s, consequent on improved fiscal
                        scenario and the accelerated disinflation process; ratings however
are still plenty of     remain below investment grade.
                                 Russian GDP reached 2,268.6 billion roubles in the second
risks in the Russian    quarter growing by 7.3 per cent (yoy), with output of the base sectors
                        remaining steady and trade surplus increasing steadily in later months
energy business;        too [Charts G.4.1-4.2]. Crude oil exports accounted for 28.4 per cent of
                        the overall exports of Russia during the first half of 2004. Russia
apart from              lowered its crude oil exports by 14.3 per cent (yoy) to 17.2 million
                        tonnes in June, but still first half exports climbed 4.2 per cent, over the
uncertainty over the
                        comparable period to 110.2 million tonnes. A $87.9 per tonne customs
licensing regime
                                                          CHART G.4.1
and taxation, there                 Main Macroeconomic Indicators for Russia in 2004 (yoy change)


is uncertainty over       120                                                                                        10.0
                                                                                                                     9.5
the construction of                                                                                                  9.0
                          115
                                                                                                                     8.5  Unemployment Rate
new oil pipelines.                                                                                                   8.0
                          110                                                                                        7.5
                                                                                                                     7.0
                                                                                                                     6.5
                          105
                                                                                                                     6.0
                                                                                                                     5.5
                          100                                                                                        5.0
                                    Jan.     Feb.    Mar.   Apr.    May       June         July   August    Sept.
                                IBS*                          Industrial Output                   Fixed Capital Investments
                                Consumer price index**        Real Personal Cash Incomes          Unemployment Level#


                        % of same period a year ago.
                        * Output dynamics index of five base sectors (industry, agriculture, construction,
                        transport, retail trade).
                        ** average for the period since the start of the year as compare to the same period
                        of the previous year.
176                     # % of total work force (ILO Methodology).
                                  CHART G.4.2                                                      ICRABULLETIN
           External Sector Indicators for Russia in 2004 (US $ billion)
                                                                                                   Money
  18.0                                                                      29.4
                                                                                                          &
  16.0                                                                      29.2
                                                                                                           Finance
  14.0
                                                                            29.0




                                                                                   Exchange Rate
                                                                                                         JULY–DEC..0 4
  12.0
  10.0                                                                      28.8
   8.0                                                                      28.6
   6.0
                                                                            28.4
   4.0
   2.0                                                                      28.2
                                                                                                     Auguring well for
   0.0                                                                      28.0
                Feb.




                                                            Aug.
                              Apr.




                                              June




                                                                    Sept.
                                                     July
         Jan.




                                        May
                       Mar.




                                                                                                     financial stability,
            Exports           Imports            Official Ruble/Dollar Exchange Rate                 Russia’s currency

                                                                                                    reserves exceeded
tariff on Russian crude oil and oil products exported outside member
states of the Customs Union has come into force from early October.                                $100 billion in mid-
Russia’s foreign trade growing 26.3 per cent (yoy) touched $21.7 billion
in June 2004, which is 4.2 per cent higher than May; exports were at                               October, for the first
$13.8 billion and imports at $7.9 billion, with a trade surplus of $5.877
billion. Industrial production index increased 5.2 per cent (yoy) for the                            time in its history,
month of August and 3.5 per cent in September. Inflation amounted to
0.4 per cent in August compared to July and to 7.6 per cent in the
                                                                                                   and are expected to
January to August period. Prices for food products advanced 0.1 per
                                                                                                    rise further, fuelled
cent in August and 7.2 per cent in comparison to the beginning of 2004;
prices for other products increased 0.5 per cent in August (4.6 per cent                                by the oil price
from January). Despite steps towards liberalisation, there are still
plenty of risks in the Russian energy business; apart from uncertainty                                            hikes.
over the licensing regime and taxation, there is uncertainty over the
construction of new oil pipelines. The government has decided to work
on creating an adequate banking system as the number of banks that
participate in joint projects with foreign partners is now growing and
there are more Russian banks that have been assigned international
credit ratings. Moreover, large international banks have been opening
their branches in Russia. The Russian trade surplus has contributed to
the rouble’s strengthening. Auguring well for financial stability,
Russia’s currency reserves exceeded $100 billion in mid-October, for
the first time in its history, and are expected to rise further, fuelled by
the oil price hikes. The central bank has resorted to buying of petro-
dollars to keep the rouble steady as the currency has already gained
substantially against the dollar in the last two years. In order to prevent
the oil gains from spurring inflation the Russian government is also
putting most of the export revenues into a stabilisation fund, which
could very well serve to improve the rating outlooks for Russia by
international agencies.                                                                                         177
 ICRABULLETIN                     Financial Markets in India
                                  Emerging markets and developing countries continue to
  Money
          &
                         experience a strong recovery, with GDP growth forecasts for 2004 being
                         revised upward markedly in all major regions. Notwithstanding the
          Finance        instability in Iraq and structural imbalances in the US economy, the
                         global economic environment and outlook continue to provide a benign
         JULY–DEC..0 4
                         backdrop for consolidating India’s growth process. According to the
                         latest WEO,3 the Indian economy appears to be in a resilient mode in
                         terms of growth, inflation and balance of payments and there are signs
                         of improvement in the investment climate in recent months. It also
                         states that despite recent adverse weather conditions, growth in India is
                         being underpinned by the global expansion and supportive monetary
                         conditions, although unfavourable patterns in this year’s monsoon are
                         raising concerns about agricultural growth. However the fact remains
                         that the prospects of the economy, which seemed bright at the turn of
                         the current financial year, have somewhat lost their shine with hopes of
The fact remains
                         second consecutive normal monsoons evaporating,4 possibility of
that the prospects of    interest rate hardening in the face of burgeoning inflation in the recent
                         past and surging international crude oil prices. The RBI, in its mid-term
the economy, which       review of Annual Policy Statement, lowered the projected GDP growth
                         for the year 2004-05 from 6.5-7.0 per cent to 6.0-6.5 per cent, assuming
seemed bright at the     that the combined downward risk of high and uncertain oil price and
                         sudden change in international liquidity environment remain
turn of the current      manageable (see Appendix). Even as it left its key policy rate, the Bank
                         rate, unchanged, the RBI has indicated a tightening bias by mentioning
financial year, have     that liquidity provided would now be appropriate instead of adequate.
                                  A variety of factors had their bearing on the financial markets
somewhat lost their
                         during the July-September quarter. These include the steadily ascending
shine.                   rate of inflation, oil-prices that are perched at high levels with hardly
                         any signs of easing, global hardening in interest rates, a depreciating
                         rupee-dollar rate and other domestic eco-political uncertainties. But the
                         factor that affected the market sentiment most, was probably the
                         unabated pace of domestic inflation, which crossed 6 per cent
                         according to data released in the first half of July [Chart F.1]. The year-
                         on-year inflation rate then surged by almost a full percentage point,
                         from 6.52 per cent for the week ended July 17, to 7.51 per cent for the
                         following week (i.e. week ending July 24) due to rising vegetables,
                         minerals and manufactured product prices. According to the apex bank,
                         both global and domestic factors such as liquidity overhang and the
                         monsoon conditions had played a vital role in the surge in inflation.
                         The promise of a measured approach on the part of the RBI somewhat
                         improved sentiments in the market in early August. But inflation


                                  3
                                     WEO, IMF, September 2004.
                                  4
                                     Faced with prospects of slowdown in the agriculture sector, in mid-
                         August, the CMIE lowered its estimate of economic growth to 6 per cent in 2004-05
178                      from the earlier forecast of 6.3 per cent.
                                     CHART F.1                                        ICRABULLETIN
                           Inflation Rate (based on WPI)
                                                                                      Money
  9                                                                                         &
  8
                                                                                             Finance
                                                                                           JULY–DEC..0 4
  7

  6

  5

  4    18-Feb-04




       16-Aug-04
       31-Aug-04
         3-Feb-04




       17-Jun-04
       18-Apr-04
       20-Dec-03
       21-Sep-03




       15-Sep-04
       30-Sep-04
        17-Jul-04
      20-Nov-03




         2-Jun-04




        1-Aug-04
        3-Apr-04
         6-Sep-03


       21-Oct-03


        5-Dec-03


       19-Jan-04




       15-Oct-04
         2-Jul-04
        5-Nov-03




      18-May-04
        6-Oct-03




      19-Mar-04
         4-Jan-04




       3-May-04
       4-Mar-04




continued its upward trend, touching 7.61 per cent for the week ended                   Surging prices of
July 31. Surging prices of fuel, commodities, fruits and vegetables since
                                                                                       fuel, commodities,
June have been largely responsible for the hike in inflation along with
the liquidity overhang. In an effort to check the alarming inflationary              fruits and vegetables
pressure, the Union Government, during the third week of August,
announced duty cuts for petrol and LPG with immediate effect. Along                      since June have
with that, allaying apprehensions on the rising inflationary
expectations and volatility in the domestic economy, the RBI again                           been largely
expressed confidence in ensuring price stability and containing the
inflationary expectations. But defying all assurances and expectations,               responsible for the
inflation touched a four-year high of 8.17 per cent for the week ended
August 21 and 8.33 per cent in the following week.5 Finally, the central                  hike in inflation
bank had to intervene by adopting monetary policy measures like
hiking CRR in the second week of September. In October the inflation
                                                                                           along with the
rate, though prevailing above 7 per cent, showed a sign of a mild
                                                                                      liquidity overhang.
diminution.

         Money and Debt Markets
         The easy liquidity in the money market witnessed throughout
the current financial year continued to persist during the July-
September quarter, with some setbacks towards the end, emanating
from the steps taken by the central bank on concern relating to a
rapidly expanding inflation rate. In July, the CMR was steady around
the narrow range of 4.13 to 4.54 per cent, ruling mostly at a sub-repo
level [Chart F.2]. Towards the middle of August, the CMR shot up to
more than 5 per cent due to heavy demand on part of a large
nationalised bank. This spurt, however, proved to be short-lived and



           5
             This was a sharp increase compared with the inflation rate of 4.4 per
cent at the beginning of this financial year (for the week ended April 3).                         179
 ICRABULLETIN                                                                                              CHART F.2
                                                                                                        CMR and Tbill Yields
  Money
          &               5.6
          Finance         5.4
                                                                                                                        CMR                              90-day                           364-day
                          5.2
      JULY–DEC..0 4
                          5.0
                          4.8
                          4.6
                          4.4
                          4.2
In a bid to check the
                          4.0




                                                                                                                        5-Dec-03
                                                                            5-Aug-03




                                                                                                                                                                                                                5-Aug-04
                                                                                       5-Sep-03




                                                                                                                                                                                                                           5-Sep-04
                                                                                                             5-Nov-03




                                                                                                                                                                                                                                                 5-Nov-04
                                                                                                                                              5-Feb-04
                                           5-May-03




                                                                                                                                                                    5-Apr-04
                                                                                                                                                                               5-May-04
                                5-Apr-03




                                                                                                  5-Oct-03




                                                                                                                                                                                                                                      5-Oct-04
                                                                                                                                   5-Jan-04
                                                      5-Jun-03
                                                                 5-Jul-03




                                                                                                                                                                                          5-Jun-04
                                                                                                                                                                                                     5-Jul-04
                                                                                                                                                         5-Mar-04
liquidity overhang in

the system, during
                        The chart is based on 6-days per week.
the second week of
                        the rate declined to as low as below 4 per cent towards the end of the
September, the RBI      month with improved liquidity condition. In a bid to check the liquidity
                        overhang in the system, during the second week of September, the RBI
hiked CRR by 50         hiked CRR by 50 basis points, to 5 per cent.6 The move was expected
                        to drain around Rs. 8,000 crore worth of liquidity from the system. The
basis points, to 5%.
                        apex bank also reduced the interest payable to banks on their eligible
The move was            cash balances maintained with the RBI under CRR requirement, to 3.5
                        per cent per annum from 6 per cent. This move followed close on the
expected to drain       heels of inflation surging to a four-year high at 8.33 per cent for the
                        week ended August 28.7 As a consequence, the call rate inched up
around Rs. 8,000        slightly, to 4.87 per cent towards the third week of the month, after
                        which it fell back to around 4.5 per cent at the end of the month. In
crore worth of          October too it hovered around 4.3 to 4.8 per cent.
                                  Trading in the government debt market had many ups and
liquidity from the      downs, influenced by many factors during the period from July to
                        September. In early July, the sentiment was bearish with steady yields
system.
                        as traders waited anxiously for the Government’s borrowing
                        programme for the current fiscal year. The stability of yields was
                        attributable to factors like the lower than expected Fed funds rate hike
                        and the RBI mop-up of close to Rs 20,000 crore from the markets
                        through its twin bonds issues8 and the MSS. This also coincided with
                        redemptions of some dated securities and treasury bills. Apart from

                                   6
                                     The CRR was raised in two stages by 25 basis points each: first, from the
                        fortnight beginning September 18 and then from October 2.
                                   7
                                     This was the first monetary measure to combat rising rate of inflation.
                        Earlier, the government tried to contain it through fiscal measures like reducing
                        customs duty on steel and excise duty on crude oil prices.
                                   8
                                     The cut-off yields for the 6.13 per cent maturing in 2028 was fixed at
                        6.70 per cent. This issue, along with the 11-year floating rate bond auction, sailed
180                     through with little difficulty.
that, the market stranded over the concern about transaction tax                            ICRABULLETIN

proposal in the Union Budget. Towards the middle of the month, this,
                                                                                            Money
along with the fears of higher inflation figures led to a sharp fall in
bond prices, a crash of around 80 paise across maturities. Moreover,                             &
towards end-July, the better than expected US consumer confidence data                            Finance
ensued to a possibility that the US Federal Reserve would be inclined to
                                                                                                 JULY–DEC..0 4
hike rates a little more aggressively. This unsettled the government
securities market, making bond prices plunge by almost a rupee across
the maturity spectrum. The surging inflation continued to drag down
bond prices in early August too, by over a rupee across medium term
maturities and this came as a blow to the confidence of the market.
                                                                                            In early September,
During the second week of the month, the one percentage point cut in
the EPF rate by the government to 8.5 per cent, failed to improve                            despite a surge in
sentiment in the government securities market.9 However, shortly after
this move, yields dropped after a weeklong rise following the re-                            inflation to a new
introduction of one-day repo by the RBI, with the repo rate unchanged
at 4.5 per cent. Also, cut in customs and excise duties on petro products                     four-year high of
lifted sentiments. But the market succumbed again when the RBI
lowered the cut-off prices at the auction of 364-day t-bills and the 6.18                     8.17%, a distinct
per cent 2005 stock under the MSS.10 Again towards the end of August,
the yields on government securities, across maturities, fell remarkably11                    impact of the new
as statements on part of the central bank that the inflation rate would
gradually soften with a substantial base effect impact created a positive
                                                                                             RBI guidelines on
impression on market sentiment.
                                                                                                   banks’ gilts
         In early September, despite a surge in inflation to a new four-
year high of 8.17 per cent, a distinct impact of the new RBI guidelines                     investments could
on banks’ gilts investments could be observed on the government
securities market, with benchmark gilts registering sharp gains of over                     be observed on the
40-120 paise. In this month, too, factors like CRR hike had a negative
impact, while ample liquidity in the system acted as a cushion to                                  government
recover some losses. Towards the end of the month, sentiment turned
distinctly bearish on the back of a spurt in world crude oil prices and                      securities market,
also renewed worries over a possible interest rate hike. These weighed
heavily on bond prices that faltered across the spectrum. In October,                          with benchmark
possibility of overshooting the government borrowing target after the
                                                                                               gilts registering
news of fall in revenue receipts added to the worsening of sentiment in
the market. Towards the middle of the month, an auction at an                               sharp gains of over
           9
              Apprehensions of the possible tightening of monetary policy to curb                40-120 paise.
inflation, and a probable 0.5 percentage point hike in the repo rate had a significant
impact.
           10
              In the process there was a devolvement of around Rs. 249 crore in the
364-day paper. The cut-off led to a fall in the prices of securities across maturities by
about Re. 1 and lifted yields.
           11
              The prices of long-term paper rose by Rs. 1.20; in the medium term the
gain was 50-60 paise.


                                                                                                        181
ICRABULLETIN                                     unexpectedly high cut-off yield12 led to a fall in bond prices of over a
                                                 rupee across maturities.
Money
        &
                                                           Maintaining the upward trend witnessed in June, the constant
                                                 maturity yield curve for July shifted entirely up from that of the
            Finance                              previous month, the rise being more pronounced at the longer end
                                                 [Charts F.3.1- F.3.2]. Yields at the shorter end hardened by around 20
       JULY–DEC..0 4
                                                 basis points while those for the longer maturities inched up by around
                                                 40 basis points. During August, yields further went up across the
                                                 maturity spectrum making the curve shift once again; the surge being
                                                 greater compared to July. The 1-year, 5-year and 10-year yields
                                                 increased by about 30, 60 and 80 basis points, respectively. In
                                                 September, however, yields more or less remained at the August level
                                                 with very little fluctuations across all maturities and this made it
                                                 difficult to distinguish the September yield curve from the one for the
                                                 previous month. The yield curve for October moved up again, with
                                                 yields for the shorter and medium term securities showing greater
                                                 increase compared to the longer term ones. Yields for the 1- and 5-year
                                                 securities inched up by around 40 to 50 basis points while that for the
                                                 15-year rose by about 20 basis points only.

                          CHART F.3.1                                                                                        CHART F.3.2
                     Constant Maturity Yields                                                                           Constant Maturity Yields


6.3                                                                                              7.0
6.0                                                                                              6.6
5.7                                                                                              6.2
5.4                                                                                              5.8
5.1                                                                                              5.4
4.8                                                                                              5.0
4.5                                                                                              4.6
4.2                                                                                              4.2
                                                                                                        CMR



                                                                                                                         1 year

                                                                                                                                  2 year

                                                                                                                                           3 year

                                                                                                                                                    4 year

                                                                                                                                                             5 year

                                                                                                                                                                      7 year

                                                                                                                                                                               10 year

                                                                                                                                                                                         15 year
                                                                                                               90 day
      CMR



                     1 year

                               2 year

                                        3 year

                                                 4 year

                                                          5 year

                                                                   7 year

                                                                            10 year

                                                                                      15 year
            90 day




       Apr-04                 May-04               Jun-04                Jul-04                               Jul-04              Aug-04                 Sep-04                Oct-04

                                                                                                Note:     October yield curve is based on data till Oct
                                                                                                          23rd.


                                                          The hardening of yields to a greater extent at the longer end
                                                 made the spread between different maturities widen during the recent
                                                 past [Chart F.4]. The spread between 1-year and 5-year government
                                                 securities was around 30 basis points during March this year, but it
                                                 shot up to around 100 basis points during September. On the other
                                                 hand, the spread between 5-year and 10-year securities went up from
                                                 about 35 basis points to more than 70 basis points during the same




182
                                                                    12
                                                                         The yield to maturity for 7.37 per cent 2014 security rose to 6.99 per
                                                 cent.
period. However, during October, the spreads between 1-year and 10-                                                           ICRABULLETIN

year and 5-year and 10-year securities declined slightly as the 10-year
                                                                                                                              Money
yield remained stable with yields at short ends moving up.
                                                                                                                                    &
                                              CHART F.4                                                                             Finance
                                    Spreads of Government Securities
                                                                                                                                   JULY–DEC..0 4


 2.0

 1.5

                                                                                                                             The spread between
 1.0
                                                                                                                               1-year and 5-year
 0.5
                                                                                                                                     government
 0.0
                                            Feb-04




                                                                                                  Aug-04
                          Dec-03




                                                              Apr-04



                                                                                Jun-04




                                                                                                           Sep-04
                Nov-03




                                                                                         Jul-04
                                   Jan-04
       Oct-03




                                                                                                                    Oct-04
                                                                       May-04
                                                     Mar-04




                                                                                                                                   securities was

                                                                                                                                around 30 basis
                         1-yr&5-yr                            5-yr&10-yr                            1-yr& 10-yr
                                                                                                                             points during March

         Foreign Exchange Market                                                                                             this year, but it shot
         The IMF in its September 2004 issue of the WEO, has
appreciated India’s achievement regarding gradual introduction of                                                              up to around 100
greater exchange rate flexibility without hiccups even when reforms to
policy frameworks were in progress. The country also maintained the                                                          basis points during
managed float without major distress even during times of international
                                                                                                                                      September.
market turbulence. In mid-term review of the Annual Policy statement,
the apex bank has addressed the widely discussed issue of foreign
exchange reserves. The RBI indicated that the overall approach to the
management of foreign exchange reserves in recent years has reflected
the changing composition of the BoP, and has endeavoured to reflect the
“liquidity risks” associated with different types of flows. Taking these
factors into account, India’s reserves are at present comfortable and
consistent with the rate of growth, the share of the external sector in the
economy and the size of risk-adjusted capital flows. In view of the level
of comfort provided by the international financial architecture, it is
necessary to provide cushions against shocks arising from uncertain
monsoon conditions in the real sector, variations in global oil prices in
the external sector and high levels of public debt in the fiscal arena.
Foreign exchange reserves thus should not be considered as an
insurance against volatility in capital flows only.
         During the July-September period, the rupee was on a
depreciating trend against the USD except some short spells of gains in
early July and the first half of September [Chart F.5.1]. From the second
week of July, the rupee-dollar rate started to lose against the dollar,
                                                                                                                                          183
 ICRABULLETIN                                               Chart F.5.1
                                                            Spot Rates
  Money
        &                      57
                               55
                                                                                                      49.2

            Finance            53
                                                                                                      48.2
                               51                                                                     47.2




                                                                                                          Dollar
                       Euro
       JULY–DEC..0 4           49
                                                                                                      46.2
                               47
                               45                                                                     45.2
                               43          Euro                                                       44.2
                               41          Dollar
                               39                                                                     43.2




                                19-Nov-03
                                23-May-03




                                17-May-04



                                25-Aug-04
                                11-Aug-03
                                31-Aug-03
                                 10-Oct-03
                                 30-Oct-03




                                 24-Oct-04
                                 3-May-03




                                  5-Aug-04
                                 23-Jan-03




                                 18-Jan-04




                                   4-Oct-04
                                 13-Apr-03
                                   3-Jan-03


                                24-Mar-03
                                  4-Mar-03




                                  7-Apr-04
                                 27-Apr-04
                                 20-Sep-03




                                18-Mar-04




                                 14-Sep-04
                                 12-Jun-03
                                 12-Feb-03




                                 26-Jun-04
                                 27-Feb-04



                                   6-Jun-04
                                   7-Feb-04
                                29-Dec-03
                                  9-Dec-03




                                  16-Jul-04
                                    2-Jul-03
                                  22-Jul-03
In view of the level

of comfort provided

by the international                                         Chart F.5.2
                                                             Spot Rates
financial
                               88
architecture, it is            86                                                                       43
                               84
                                                                                                        42
                               82
necessary to provide
                               80                                                                       41
                       Pound




                                                                                                             Yen
                               78
cushions against               76                                                                       40
                               74                                                                       39
                                                                                 Pound
shocks arising from            72                                                Yen
                               70                                                                       38
                                    19-Nov-03
                                    11-Aug-03
                                    31-Aug-03




                                    25-Aug-04
                                     10-Oct-03
                                     30-Oct-03




                                     24-Oct-04
                                     23-Jan-03




                                    23-May-03
                                     12-Jun-03




                                     18-Jan-04




                                    17-May-04


                                      5-Aug-04
                                     13-Apr-03




                                     26-Jun-04



                                       4-Oct-04
                                     3-May-03




                                     27-Apr-04
                                       3-Jan-03




                                     20-Sep-03




                                    18-Mar-04




                                     14-Sep-04
                                      7-Apr-04
                                    24-Mar-03
                                     12-Feb-03
                                      4-Mar-03




                                     27-Feb-04



                                       6-Jun-04
                                      22-Jul-03




                                       7-Feb-04




                                      16-Jul-04
                                        2-Jul-03




                                    29-Dec-03
                                      9-Dec-03




uncertain monsoon

conditions in the

real sector,
                       going above Rs. 46. Persistent dollar demand from corporates and
variations in global   small inflows from foreign funds dragged the rupee down. However, the
                       intervention on part of the central bank to curb any sharp fall extended
oil prices in the      limited support to the rupee. In August, the rupee faced downward
                       pressure caused by soaring international oil prices and upward moving
external sector and    domestic inflation, but the exchange rate was more or less stable
                       around Rs. 46.19 to 46.43. However, in September, with concerns over
high levels of
                       rising oil prices mitigating, the rupee strengthened and ruled below Rs.
public debt in the     4613 for the rest of the month, before it started to weaken again from
                       the fag end of the month. In October however, it recovered and
fiscal arena.          returned to its gaining track and the exchange rate fell below Rs. 46
                       again. The rate averaged around 45.8 till the third week of the month.
                       Among other major currencies, the rupee was quite stable during the
                       past few months against euro, pound and yen [Chart F.5.2].

                                 13
                                    The rupee was little moved by the inflation flutter, though the inflation
184                    at more than 8 per cent rattled debt and equity investors.
                                   Chart F.5.3                              ICRABULLETIN
                          Annualized Premia (3 Month)
                                                                            Money
  4
  3
                                                                                  &
  2                                                                                Finance
  1
                                                                                 JULY–DEC..0 4
  0
 -1
                 Dollar
 -2
                 Euro
 -3
 -4



       19-Nov-03
       23-Jan-03




       12-Jun-03




       18-Jan-04




       26-Jun-04
        3-Jan-03




        6-Jun-04
        22-Jul-03




        16-Jul-04
         2-Jul-03
      12-Feb-03




      27-Feb-04
        7-Feb-04
        4-Mar-03
      24-Mar-03
       13-Apr-03




      18-Mar-04

       27-Apr-04
        7-Apr-04
      11-Aug-03
      31-Aug-03
      20-Sep-03




      29-Dec-03




      25-Aug-04
      14-Sep-04
        9-Dec-03




        5-Aug-04
       10-Oct-03
       30-Oct-03




       24-Oct-04
        4-Oct-04
       3-May-03
      23-May-03




      17-May-04
                                                                               The trend of the

                                                                           three-month premia

                                   Chart F.5.4                             remaining above the
                          Annualized Premia (3 Month)
                                                                                 six-month one
  5
  4                                                                        observed since June
  3
  2                                                                                this year still
  1
  0
 -1
                                                                           continues, implying
 -2            Pound
 -3            Yen
                                                                             that the outlook of
 -4
      19-Nov-03
      11-Aug-03
      31-Aug-03




      25-Aug-04
       10-Oct-03
       30-Oct-03




       24-Oct-04
       23-Jan-03




      23-May-03
       12-Jun-03




       18-Jan-04




      17-May-04



        5-Aug-04
       13-Apr-03




       26-Jun-04
       27-Apr-04




         4-Oct-04
       3-May-03
         3-Jan-03




       20-Sep-03




      18-Mar-04




       14-Sep-04
        7-Apr-04
      24-Mar-03
       12-Feb-03
        4-Mar-03




       27-Feb-04




         6-Jun-04
        22-Jul-03




         7-Feb-04




        16-Jul-04
          2-Jul-03




      29-Dec-03




                                                                           the rupee-dollar rate
        9-Dec-03




                                                                            in the shorter term

                                                                             is more uncertain
Particularly, from the second half of September the rupee strengthened
against pound and yen.                                                     than in the relatively
         A notable phenomenon in the foreign exchange market has
been that the pace of accretion of foreign exchange reserves has                   longer term.
somewhat receded during the last four months. It has shrunk from USD
million 1,19,511 during June to 1,18,359 in end-September, with some
fluctuation from time to time. In October it again increased slightly to
become USD million 1,19,284.
         Forward premia for dollar was mostly in tune with the
movement of the rupee-dollar exchange rate during the second quarter
of the financial year, except for September. The three-month and six-
month annualised premia hardened considerably, tracking the
weakening rupee, by more than 100 basis points, from early July till
the end of the month [Charts F.5.3- F.5.4]. In August, premia remained
stable with small fluctuations. However, in September, forward premia
started to decline with an appreciating rupee. Especially during the
third week, they dipped below 2 per cent, just after which, started to                   185
 ICRABULLETIN          rise again, defying the rupee’s strengthening, probably on concerns
                       relating to surging inflation and international oil prices. The premia
  Money
           &
                       continued to remain more or less stable till the third week of October,
                       slightly inching up from the previous month. The trend of the three-
           Finance     month premia remaining above the six-month one observed since June
                       this year still continues, implying that the outlook of the rupee-dollar
       JULY–DEC..0 4
                       rate in the shorter term is more uncertain than in the relatively longer
                       term.
                                 As a positive development, Standard & Poor’s, during the latter
                       half of August, raised its outlook on India’s long-term foreign currency
                       as well as local currency ratings. The outlook on BB long-term foreign
The unrelenting
                       currency rating was raised from stable to positive, while that of BB+
escalation in          long-term local currency rating from negative to stable. The outlook
                       revisions reflect India’s improving external liquidity and better
international oil      prospects for the government’s debt burden to stabilise. India’s robust
                       foreign exchange reserves, which exceed 2000 per cent of short-term
prices has been the    debt, mitigate the risk of volatility in external confidence.

main player in                  Capital Markets
                                In capital markets across the globe the transition from a low
capital markets over   interest rate regime to a more stringent policy regime started off rather
                       smoothly, aided by a number of factors such as adequate pre-warning
the globe during       from the US FOMC and the assurance of measured increases with
                       relatively low inflationary pressures; the large official purchases of US
recent months.
                       dollar-denominated bonds, in particular, by Asian central banks, which
Trading in equity      have provided a stabilising influence in the bond and foreign exchange
                       markets; and finally, higher economic growth, which has supported the
markets across         credit quality and earnings prospects of corporations in most
                       economies.14
several countries               The unrelenting escalation in international oil prices has been
                       the main player in capital markets over the globe during recent
remained ashen due     months. Trading in equity markets across several countries remained
                       ashen due to concerns over energy costs cutting into corporate profits.
to concerns over       Even relatively strong second quarter corporate earnings failed to arrest
                       a general downward drift in major indices except in a few markets,
energy costs cutting
                       notably South Korea and Taiwan, which yielded good returns
into corporate         particularly due to a domestic rate cut and flush of foreign institutional
                       investments, respectively in these countries. In the US markets, the
profits.               industrial blue-chip index, the DJIA15 [Chart F.6] trended down in July,
                       closing the month with a 295.77 point difference from its closing value
                       in June; though there was a slight improvement in the index by end-

                                  14
                                     Corporate balance sheets have continued to improve across countries in
                       varying degrees and global corporate default rates have come down markedly in the
                       year so far.
                                  15
                                     The DJIA is not limited to traditionally defined industrial stocks, but the
                       index serves as a measure of the entire US market, covering such diverse industries as
186                    financial services, technology, retail, entertainment and consumer goods.
                                                                               CHART F.6                                                                                                                                                          ICRABULLETIN
                                                                       The US Stock Indices in 2004
                                                                                                                                                                                                                                                  Money
   2300
                                                                                                                      NasdaqComposite                                                             DJIA
                                                                                                                                                                                                                                          10700         &
   2200
                                                                                                                                                                                                                                          10600
                                                                                                                                                                                                                                          10500
                                                                                                                                                                                                                                                         Finance
                                                                                                                                                                                                                                          10400        JULY–DEC..0 4
   2100
                                                                                                                                                                                                                                          10300
   2000                                                                                                                                                                                                                                   10200
                                                                                                                                                                                                                                          10100
   1900
                                                                                                                                                                                                                                          10000
                                                                                                                                                                                                                                          9900
   1800
                                                                                                                                                                                                                                          9800
   1700                                                                                                                                                                                                                                   9700
                                                                                                      10-May-04
                                                                                                                  25-May-04
                     20-Jan-04




                                                                   23-Mar-04
          2-Jan-04




                                                                                                                              10-Jun-04
                                                                                                                                          28-Jun-04


                                                                                                                                                                  29-Jul-04
                                                                                                                                                      14-Jul-04


                                                                                                                                                                              13-Aug-04
                                                                                                                                                                                          30-Aug-04
                                                                                                                                                                                                      15-Sep-04
                                                                                                                                                                                                                  30-Sep-04
                                                        8-Mar-04



                                                                                          23-Apr-04
                                            20-Feb-04



                                                                               7-Apr-04
                                 4-Feb-04




                                                                                                                                                                                                                              15-Oct-04
                                                                                                                                                                                                                                                  In the Indian capital

                                                                                                                                                                                                                                                  markets, apart from
August—higher by 34.21 points from July-end—the index again trended
down in September closing at 93.65 points lower than August. The                                                                                                                                                                                  the external factors,
technology stock heavy Nasdaq index, on the other hand, seems to
have suffered less, ending July with a fall of 83.03 points from its June’s                                                                                                                                                                        domestic inflation
closing, then going down another 88.95 points by end-August,16 but
recovering by 63.19 points by end-September. In October, the DJIA                                                                                                                                                                                      and budgetary
suffered further, and reached historic lows in the third week of October,
due to ebbing market sentiments, stemming primarily from anxiety on
                                                                                                                                                                                                                                                  proposals also had
further hikes in oil prices and the upcoming US presidential elections.
                                                                                                                                                                                                                                                        a role to play.
The Nasdaq however remained relatively stable in this period too.
         In the Indian capital markets, apart from the external factors,
domestic inflation and budgetary proposals also had a role to play.
Union Budget 2004-05, in early July 2004, led to some amount of
volatility in the market due to the proposal of imposing a turnover tax
on transactions in a stock exchange, at the rate of 0.15 per cent of the
value of the security transacted, payable by the buyer, in lieu of capital
gains tax;17 the BSE Sensex [Chart F.7] registered an intra-day drop of
over 100 points, while NSE Nifty fell by nearly 49 points. As a fallout
of protests by the brokers of stock exchanges all over India, on July 21,
the proposals were amended by significantly lowering the tax burden
and by proposing a new STT regime with different tax rates for


           16
              Profit warnings issued by National Semiconductor acted as a dampener
on technology stocks. However, Internet major Google made a strong debut on
Nasdaq on August 18, after its IPO, in which it sold 25.7 million shares.
           17
              The finance minister proposed to abolish the current 10 per cent tax on
long-term capital gains from securities transactions. In the case of short-term capital
gains from securities, he proposed to reduce the rate of tax to a flat rate of 10 per
cent; short-term gain is aggregated with taxable income from other income classes
and the short-term capital gains tax is levied at personal income tax rates.                                                                                                                                                                                   187
 ICRABULLETIN                                            CHART F.7
                                                Movement in Indian Stock Indices
  Money
         &                      6000                                                                1950
          Finance               5700                                                                1850




                        BSE Sensex




                                                                                                           NSE Nifty
                                5400                                                                1750
       JULY–DEC..0 4
                                5100                                                                1650

                                4800                                                                1550
                                               BSE-Sensex
                                4500                                                                1450
                                               NSE-S&PCNXNifty
                                4200                                                                1350




                                         9-Mar-04

                                         2-Apr-04




                                        11-Oct-04
                                        23-Oct-04
                                         4-Dec-03




                                       21-Mar-04
                                        17-Oct-03
                                        29-Oct-03




                                          9-Jan-04
                                        16-Dec-03
                                        28-Dec-03




                                        14-Apr-04




                                           7-Jul-04
                                        26-Apr-04
                                        21-Jan-04
                                       10-Nov-03
                                       22-Nov-03




                                          5-Sep-04
                                        8-May-04

                                          1-Jun-04




                                         31-Jul-04
                                         19-Jul-04
                                         2-Feb-04




                                        13-Jun-04
                                        25-Jun-04



                                       12-Aug-04
                                       24-Aug-04
                                       20-May-04




                                        17-Sep-04
                                        29-Sep-04
                                        14-Feb-04
                                        26-Feb-04
While surging

international oil

prices were taking
                       different types of securities. In the third week of July, market players
their toll of the      responded positively to the announcement that the 0.15 per cent STT
                       proposed in the Budget would not only be slashed to 0.015 per cent on
market sentiment       the value of the transactions but also would be confined to only
                       delivery-based trade in equities, even while totally exempting sale and
since early August,    purchase of bonds from the levy. Day-traders and arbitrageurs have
                       been virtually freed of the levy as they have been allowed to set off
the weekly inflation
                       their entire STT liability against the tax paid on business profits. A
figures, released in   similar concession has been made to derivative traders, as the STT rate
                       applicable on future and options trades has been pegged even lower at
the middle of the      0.01 per cent. The Sensex crossed the psychologically important 5000
                       mark barrier in the third week of July, and moved up consistently since
month, further         then. While surging international oil prices were taking their toll of the
                       market sentiment since early August, the weekly inflation figures,
dampened the           released in the middle of the month, further dampened the bourses; the
                       annual WPI inflation, which had already edged to 7.6 per cent, surged
bourses.               to a new high of 7.96 per cent in the week ended August 7 due to
                       higher energy and manufactured product prices. This led to losses,
                       particularly in auto, pharma and cement stocks, and the BSE Sensex,
                       which had earlier crossed 5250, ended at 5064.66 and the NSE Nifty
                       also closed lower. Inflation, which reached a peak of 8.3 for the last
                       week of August, came down gradually to 7.2 for early October.
                       Sentiments improved through end-August to September, and the Sensex
                       crossed the 5500 mark by mid-September. In fact, from the lows of
                       Black Monday—May 17, 2004—the stock markets bounced back by an
                       encouraging 20 per cent in the past four months, with market
                       capitalisation also increasing by Rs. 242,000 crore in these four
                       months.18 The CBDT had notified October 1 as the date from which the

                                  18
                                     As per the Business Standard Research Bureau almost all sectors,

188                    classified by them, except the automobile (cars) segment, gained. Of the 2,213
                       actively traded stocks on the BSE, almost 83 per cent (1,835 stocks) have
new STT regime would come into force in respect of all taxable                            ICRABULLETIN

securities transactions;19 the Sensex surged over 90 points on this day
                                                                                          Money
and crossed 5750 in October. In the third week of October, further
threats from oil prices and fall in global markets dampened sentiment,                          &
with there being an all-round selling pressure, especially in mid-cap                            Finance
and banking stocks. However, following the international trends, 20 oil
                                                                                               JULY–DEC..0 4
and technology heavyweights Reliance21 and Infosys held up the market
from any major fall.
         With oil prices climbing up steadily since the summer of 2004,
energy stocks have performed well internationally. The BSE Oil and
Gas sector index was launched effective August 23, 2004 to capture the
                                                                                          In the third week of
movement in this sector [Chart F.8]. The BSE OILGAS index, which
covers 90 per cent of the sectoral market capitalisation and is based on                      October, further
the Free-Float methodology,22 trended up steadily from the initial levels
of 2500 points to over 3000 points by mid-October. After this the index                       threats from oil

                                 CHART F.8                                                   prices and fall in
                   Movement of Domestic Oil & Gas Stock Prices
                                                                                               global markets
   3100
                                                                                                   dampened
   3000

   2900                                                                                       sentiment, with
   2800                                                                                    there being an all-
   2700
                                                           BSE OILGAS Index                     round selling
   2600
   2500                                                                                   pressure, especially
          23-Aug-04
          26-Aug-04
          29-Aug-04




          10-Oct-04
          13-Oct-04
          16-Oct-04
          19-Oct-04
           1-Oct-04
           4-Oct-04
           7-Oct-04
          10-Sep-04
          13-Sep-04
          16-Sep-04
          19-Sep-04
          22-Sep-04
          25-Sep-04
          28-Sep-04
           1-Sep-04
           4-Sep-04
           7-Sep-04




                                                                                              in mid-cap and

                                                                                              banking stocks.
Starting August 23rd, 2004 with February 1, 1999 = 1000 .




appreciated in value, while only 17 per cent (378 scrips) have lost ground in the last
four months. The rally is led by mid-cap stocks, with the NSE S&PCNX Mid-cap
index rising to an all-time high of 1930.40, up 37.47 per cent in the last four months.
           19
               Any purchase or sale of an equity share in a company or a derivative or
a unit of an equity-oriented unit, entered into in a recognised stock exchange, or sale
of a unit of an equity-oriented fund to a mutual fund would be considered as
taxable securities transaction.
           20
              Energy stocks such as Statoil (Norway), ENI (Italy) and France’s Total
helped markets recover across the euro zone. The Nasdaq’s stability helped IT stocks.
           21
               Reliance reported a 39 per cent jump in its second quarter net profit at
Rs. 17.52 billion.
           22
               The constituent stocks (with their respective weightages) are Bharat
Petro (0.35), Castrol (0.30); Chennai Petro (0.35), Gail (India) Ltd (0.35),
Hindustan Petro (0.50), Indian Oil (0.10), Kochi Refinery (0.50), MRPL(0.15),
ONGC(0.15) and Reliance Industries (0.55).                                                             189
 ICRABULLETIN          dipped slightly, possibly due to the unexpected announcement of IOC
                       posting a 31 per cent fall in post-tax earnings in the second quarter
  Money
        &
                       despite a 19 per cent rise in gross turnover.23
                                 The SEBI has revised the eligibility criteria for stocks and
         Finance       indices on which futures and options can be introduced. According to
                       the new rules, effective September 1, stocks will be chosen from among
       JULY–DEC..0 4
                       the top 500 scrips in terms of average daily market capitalisation and
                       average daily traded value for the previous six months on a rolling
                       basis. Derivative contracts on an index can now be introduced by stock
                       exchanges if 80 per cent of the index constituents are individually
                       eligible for derivatives trading. However, no single ineligible stock in
In August the United
                       the index can have a weightage of more than 5 per cent in the index.
Nations Employees      The index on which futures and options contracts are permitted will be
                       required to comply with the eligibility criteria on a continuous basis,
Pension Fund has       according to the market regulator.
                                 The LSE identified India, China and Russia as the core markets
registered itself as   for future growth as global companies are increasingly focussing on
                       these markets. In August the United Nations Employees Pension Fund
an FII in India,       has registered itself as an FII in India, following the lead shown by such
                       large entities as California Public Employees Retirement System
following the lead     (CalPERS). FIIs continue to invest aggressively in Indian equities;
                       between August 2004 and October 21, FIIs reported a net inflow of $1.4
shown by such          billion into Indian equities—second only to Taiwan, which witnessed a
                       $3.8 billion influx during the same period. In August FIIs invested a net
large entities as
                       of Rs. 2892.30 crore in the equity markets, while they withdrew a net
California Public      amount of Rs. 371.4 crore from the Indian debt market. In September
                       FIIs brought in Rs. 2385.60 crore and Rs. 189.70 crore worth of funds
Employees              to the country through their investments in the equity and debt markets,
                       respectively. FII investment in equities was positive in October24 at
Retirement System.     Rs. 2278.5 crore, while they were net sellers in the debt market with
                       net outflows of Rs. 602.2 crore.
                                 Domestic MFs have been net sellers in equity markets till
                       October so far; after net purchases of Rs.1005.09 crore in equities in
                       May, MFs consistently withdrew funds from the market to register a net
                       outflow of Rs. 970.77 crore during the current financial year so far
                       (April to October 21, 2004); the outflow in October was the largest and
                       to the tune of Rs. 700 crore. On the other hand, their investment in debt
                       securities in the fiscal year has been a good Rs. 4585.6 crore. Equity
                       funds have been selective in their stock picking and, in particular, have
                       bought into banking and steel sector stocks, but they have bailed out of
                       oil, IT, pharmaceutical, auto and cement sector stocks. There was also


                                 23
                                      Given that retail prices of transportation fuels were not revised
                       sufficiently upwards to reflect the jump in global oil prices, a fall in profits was
                       certainly expected, but not to the extent brought about mainly by under-realisations
                       from petrol and diesel and the subsidy on cooking gas and kerosene.
190                                24
                                      Up to the 21st of the month.
evidence of their continuing interest in undiscovered mid-cap and                     ICRABULLETIN

small-cap stocks.25 The net outflow from the secondary markets comes
                                                                                      Money
as a surprise as MFs are witnessing an increase in investor interest in
equity or equity-linked schemes, which is reflected in the net addition of                  &
Rs. 371 crore to total equity assets managed between May and                                 Finance
September 2004, according to AMFI. Withdrawal from the secondary
                                                                                           JULY–DEC..0 4
market may possibly be explained by the increased liquidity
requirements for investing in the numerous primary issues on the anvil.
         In the primary market, in early August, India’s top software
services exporter Tata Consultancy Services Ltd. concluded its IPO,
which raised Rs. 54.2 billion; the TCS IPO was oversubscribed by eight
                                                                                          The net outflow
times.26 The 865.8 million-share NTPC offer in mid-October, which
was a combination of new shares and a sale by the Government, raised                  from the secondary
Rs. 53.86 billion. Though the stock market has been in a volatile phase
after the massive crash in May, fund houses are launching new schemes                 markets comes as a
mostly to expand their product basket as also to fill gaps in the risk-
return spectrum. Notably, schemes launched in the recent past were not                surprise as MFs are
just plain vanilla diversified equity schemes, but most have different
stock picking themes.27                                                                    witnessing an
         The Securities Market Infrastructure Leveraging Expert Task
Force28 has called for far-reaching changes in the primary market                     increase in investor
procedures. The SMILE report notes that the progress in the two
segments of the Indian securities market has been uneven; while the
                                                                                      interest in equity or
secondary market has shown greater resilience and absorbed
                                                                                            equity-linked
technology to the extent that it can now be compared to the best stock
exchange systems in the world, the new issues market has languished                    schemes, which is
partly because the number of quality offerings has not been steady, and
primary market intermediaries probably found no reason to upgrade in                   reflected in the net
the absence of steady business. If some suggestions of the report are
implemented one could expect considerable revamping of the primary                    addition of Rs. 371
issues segment of the Indian securities market.
                                                                                      crore to total equity

         [Section closed on October 26, 2004]                                            assets managed

                                                                                        between May and

                                                                                        September 2004,
           25
              Equity funds bought into stocks such as JK Paper, KEC International,    according to AMFI.
Ricoh India, Bongaigaon Refinery and IDBI Bank.
           26
              Later, TCS reported an increase of 51.8 per cent in its net profit
(excluding exceptional items) and a 43.5 per cent increase in consolidated revenues
for the quarter ended September 30.
           27
              These are, for instance, Kotak opportunity fund, and the ING Vysya
domestic opportunities fund. In August-September, ABN Amro MF raised Rs. 388
crore in its IPO of a floating rate fund. In October, HDFC MF has garnered Rs. 400
crore in its Core & Satellite Fund and Rs. 600 Crore in its Multiple Yield fund.

                                                                                                   191
           28
              SMILE Task Force First Report on Infrastructure And Process Flows For
The Primary Market, SEBI.
ICRABULLETIN               Appendix: Mid-term Review of Annual Policy Statement
                           for the year 2004-05
Money
      &
                            The overall stance of monetary policy for 2004-05, as stated by
                   the apex bank, would be to provide appropriate liquidity in order to
      Finance      meet credit growth and support investment and export demand in the
                   economy, while placing equal emphasis on price stability. Also, an
   JULY–DEC..0 4
                   interest rate environment conducive to macroeconomic and price
                   stability would be pursued, maintaining the momentum of growth at
                   the same time. Whenever necessary, measures would be taken in a
                   calibrated manner, in response to evolving circumstances with a view
                   to stabilising inflationary expectations. As the magnitude and
                   persistence of supply shock was partly unanticipated, demand
                   management needs closer attention, particularly for stabilising
                   inflationary expectations.
                            Although global economic recovery is gaining strength, there is
                   some increase in downside risk primarily on account of persistence of
                   uptrend in global oil prices. For the past six months, the developments
                   in the domestic and external fronts were like the following in a
                   nutshell. GDP growth projection for 2004-05 was brought down in the
                   range of 6.0-6.5 percent from the earlier expectation of 6.5-7.0 per
                   cent. Annual inflation, as measured by point-to-point variations in the
                   WPI, rose from 4.6 per cent at end-March to 8.3 per cent in end-August
                   but has since come down to 7.1 per cent by October 9, 2004. Money
                   supply (M3) growth in this fiscal year (up to October 1, 2004) is lower
                   at 5.4 per cent as compared with 7.8 per cent in the previous year. The
                   pick-up in investment activity and significant growth in non-food credit
                   (11.5 per cent) appear to be broad based and are not temporary
                   phenomena. The Central Government has completed gross market
                   borrowings of Rs. 75,044 crore in the fiscal year (up to October 21,
                   2004), which is 49.8 per cent of the budgetary amount. The market
                   borrowing programme in the remaining part of the year needs to be
                   calibrated carefully in view of strong credit demand. Financial markets
                   have remained generally stable though the government securities
                   market tended to show some nervousness in recent months. The market
                   interest rates have displayed some upward movement, particularly at
                   the longer end. The exchange rate of the rupee depreciated vis-à-vis US
                   dollar, Euro, Pound sterling and Japanese yen by October 21, 2004.
                   Foreign exchange reserves increased by US$7.6 billion from US$113.0
                   billion at end-March 2004 to US$120.6 billion as on October 21, 2004.
                   India’s exports during April-September 2004 increased by 24.4 per cent
                   in US dollar terms, while imports rose faster by 34.3 per cent. The
                   higher trade deficit reflects high oil imports bill as also the growth in
                   overall import demand. The current account remained in surplus
                   consecutively over the past three years, the current account in the first
                   quarter of 2004-05 also posting a surplus of US$1.9 billion.

192
    Financial Sector Reforms and Monetary Policy Measures:            ICRABULLETIN

    Highlights
                                                                      Money
•
•
    Bank Rate kept unchanged at 6.0 per cent.
    Repo Rate increased by 25 basis points to 4.75 per cent.              &
•   Revised Liquidity Adjustment Facility to operate with                 Finance
    overnight fixed rate repo and reverse repo.
                                                                         JULY–DEC..0 4
•   Ceiling on Interest Rates on NRE Deposits raised by 50 basis
    points over US dollar LIBOR/SWAP rates of corresponding
    maturities.
•   Limit on advances under priority sector enhanced for
    improving credit delivery to the agriculture sector.
•   Banks to increase their disbursements to small and marginal
    farmers under special agricultural credit plans (SACP) by
    March 2007.
•   Private sector banks are urged to formulate SACPs from the
    year 2005-06, targeting an annual growth rate of at least 20-25
    per cent.
•   Composite loan limit for SSI entrepreneurs enhanced from
    Rs. 50 lakh to Rs. 1 crore.
•   Investment by banks in securitised assets pertaining to SSI
    sector to be treated under priority sector.
•   Banks may now extend direct finance to housing sector up to
    Rs. 15 lakh under priority sector lending.
•   Banks are urged to keep up the momentum of lending to
    agriculture.
•   The minimum maturity period of CP is reduced to seven days.
•   Automated value-free transfer of securities between market
    participants and the CCIL facilitated.
•   Capital Indexed Bonds to be introduced during the year 2005-
    06 in consultation with the Government.
•   The ceiling on MSS raised from Rs. 60,000 to Rs. 80,000
    crore.
•   The RBI would prepare draft guidelines for implementation of
    Basel II norms and place them in the public domain.
•   Dissemination of credit information by CIBIL for improving
    asset quality of banks.
•   Enhancement of Capital Base for Asset Reconstruction
    Companies to 15 per cent of assets acquired, or Rs. 100 crore,
    whichever is less.




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