Inflation: Managing the necessary evil

Almost halfway into the 3rd quarter and well into the busy season, the economy is well set to make a comeback with projected growth of 6% upwards. With markets again close to the pre-crisis levels and major sectors looking up, it is only a question of time when we are able to leave the recession blues behind us. While this seems good news, market participants having become accustomed to easy monetary policy for the past year are keenly watching when the central bank reverses its stance. One of the factors driving this sentiment is inflation which has clearly been the baritone of the last two quarterly policy statements of the RBI Governor. While the base effect of last year played out for most part of this fiscal, it is projected to become a threat by March 2010.
While inflation projected to break 6% levels by March 2010 it is a question of time when the central bank is compelled to raise interest rates. However, many market participants believe that inflation is not a prime concern as it is heading towards the levels where it should be. While we would partly agree to that, we would like to look at the levels where policy makers would want to stop the prices to spiral any more. With the monthly release of data and the new series for WPI being launched shortly, it is very apparent the authorities have partly found an alternative (apart from raising interest rates) to manage inflation in the short term.
Raising interest rates in the current scenario is just not an option as the economy is still suffering from a supply driven inflation due to bad monsoon and lower production levels during the recession. Credit growth is yet to pick up to the normal levels. Hence managing inflation statistically seems to be a very smart move on the part of the policy makers. Measures like increasing the time frame of release of data would help in smoothing out effect of the numbers. Further, incorporating electronic goods would drive down the manufactured item index which is likely to constitute 80% of the WPI. While it is anyone’s guess as to when the new WPI series would come into effect, we would try to look at few ways in which the inflation might pan out in the next 4 months. While we would forecast the inflation we still believe that the WPI still continues to a flawed number with many components (around 15-18% of many components) not been for many months. We believe that the monthly release would ease out volatility and would also manage short term spikes.
Here we look at 4 likely scenarios which would help us identify the paths inflation is going to take in the remaining period of the current fiscal.

Case 1:- Assuming the index remains the same as on October 2009 for the remaining part of the year.

Case 2:- Taking monthly average growth rates for various components of WPI for the last year (Oct-08 to Oct-09) i.e. the current inflation cycle

Case 3:- Taking monthly average growth rates for various components of WPI from the last inflation cycle between Jun-07- Oct-08

Case 4:- Outlines the most likely scenario that policymakers might be able manage without much ramifications

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Conclusion
From the four scenarios presented above we can see that inflation would be definitely above 6% by March 2010. While all the scenarios are closely likely, keeping in mind political ramifications we expect Case -4 to be the most likely path that would be followed in coming months. It is evident that food inflation constituting around 3.4% of the WPI is at its historic highest levels. Although the government does not have any impending threat vis-a-vis elections food inflation close to 20% (as in Case 2 following the growth rate of past 12 months) does have very serious political ramifications. Hence we can safely assume that food inflation would either not be allowed to rise very high and policy makers would cap the food prices to a certain level. With the current scenario the policy makers have effectively managed inflation and we believe the numbers can be and would be “managed” smartly, kept under control around the projected levels of around 6-7% before the central bank is comfortable in raising interest rates sometime early next fiscal.

Shipping Stocks on the Shine

The Baltic Dry Index (BDI) has clocked its highest weekly gains this year and was at its yearly highs at 4381 up 161 points or 3.85%
The Baltic Dry Index has been on a rise since 14 consecutive sessions and has gained more than 60% in the last one month

Reasons

This has come mainly due to an increase in demand from China as iron ore imports in the country are on a rise

Lower Interest rates have also helped the cause as easy availability of credit has made it easier to get a letter of credit for the vessels

Ship congestion at Brazil, Australia & China have also contributed to the rise in the index

Conclusion

Shipping stocks have rallied with stocks gaining strength like Mercator Lines (12.51%), SCI (0.23), Essar Shipping (2.59%), Great eastern Shipping(8.60%)

GE Shipping, Mercator Lines & Shipping Corp. India are stocks with good fundamentals and likely to take the major gains as BDI is the major factor for any movement in shipping stocks

Author: Rahul Sonthalia, Analyst, Kredent Group

USD/INR Downside Prevails

The week saw consolidation across the board with all equity markets rebounding from the selling momentum of last week. The Sensex rebounded around 700 points. Similarly all major indices have risen defying the fact that unemployment still is a concern for the US. The Euro broke the 1.5000 mark during the week and currently trades at 1.49. The forecast for the pair still remains bullish with more buying expected during the week adding to more bearish sentiments to the USD.

Exchange Rates

Major pairs	06/11/2009	14/11/2009
EUR USD	1.4879	1.4903
GBP USD	1.6607	1.6676
USD JPY	90.64	89.29
USDINR	46.80	46.34
GBPINR	46.80	46.34
100JPY/INR	52.07	51.57
EURINR	69.49	68.87

Key International Indices and Commodities

Index	06-11-2009	14-11-2009
DowJones	10023.42	10270.47
NASDAQ	2112.44	2167.88
SENSEX	16158.28	16848.83
NIFTY	4796.15	4998.91
FTSE	5142.72	5296.38
NIKKEI	9789.35	9770.31
GOLD	1092	1116.70
OIL	78.51	76.35

USD/INR Weekly outlook

The USD INR broke the 46.77 support level during the week and was bearish for major part of the week. Every uptick continues to add more shorts to the market and upside remains far off at 46.77 levels. Upside can only be confirmed if it breaks above these levels. More downside would be confirmed if break above 46.35 levels is confirmed.

USD/INR Weekly outlook

Sell Equity and Base Metals

On October 20th 2009 Bloomberg reported a news snippet saying that “ European finance officials are concerned the Euro’s climb to a 14-month high against the dollar is eroding exports”.

The same day French President Nicolas Sarkozy called the move a “disaster” for the economy.

Since February Euro has gained almost 20 percent against the dollar making the Euro zone’s exports more expensive to overseas buyers and threatening the economic recovery from the worst recession since World War II.

Sarkozy’s counselor, Henri Guaino, said that the U.S. is “flooding the world” with dollars and that the currency’s weakness may become “unbearable.” An exchange rate of $1.50 per euro “is a disaster for the European economy and manufacturing sector.

Treasury Secretary Timothy Geithner said on Oct. 3 that it is “very important” for the U.S. to have a strong dollar the reason being US is primarily an importing country and a further weakening of dollar could lead to significantly high levels of current account deficits

In view of this, I strongly believe that the European Central Bank would take every possible step to ensure that its currency does not appreciate further.

Couple of weeks back when Euro was near 1.5, Nifty index was around 5200 and other major global indices was also at their peak. Then what happened was the Nifty corrected to 4500 levels and other global indices also had the same fate. This however was accompanied by Euro reaching almost 1.47 levels unnoticed.

The relation is that, if Euro weakens form here, that means dollar will gain strength and with dollar gaining strength comes the correction in all major base metals and crude. Moreover, in almost all the top world indices, whether Dow Jones or Nikkei or Nikkei, the weight of commodity driven stocks is the maximum. Thus a correction in global commodities because of a weakening euro will inevitably lead to a correction in the global equity markets.

Again since a correction did take place some time back, there is a strong possibility that it shall repeat itself, given the fact that Euro is nearing 1.5.

Hence, I believe the trading strategy one could adopt currently is to go short on the Nifty Index, base metals, crude and commodity driven stocks like Crain India, Reliance Industries, Hindalco, Tata Steel, Sesa Goa, Sterlite, etc. The stop loss one should keep is a Euro level of above 1.51.

Author: Rahul Sonthalia, Analyst, Kredent Group

INFLATION: Change, but not yet wholesale

The Cabinet Committee on Economic Affairs has given its approval on the much needed & awaited revamp of the WPI

WPI taken to be a major indicator of Inflation in India will now be calculated on a monthly rather than a weekly basis

This change in the periodicity was based on the recommendation of a working group headed by economist Mr. Abhijit Sen, member Planning Commission

Monthly system, followed globally, will be followed for manufactured subgroup in tandem with the overall WPI

However, in order to monitor prices of agriculture commodities & petroleum products, a price index for primary & fuel, power, light & lubricant group will be reported on a weekly basis

The first such weekly report was released on the 5th Nov for the week ending 24th Oct, 2009

Reporting of the monthly WPI will commence on the 14th November, 2009

The working group had made other important recommendations as well, which the govt. will likely implement later

These recommendations are likely to address the issues faced by the old calculation system

Most pertinent being data in-availability of most of the manufactured articles

Earlier the WPI was compiled with prices of only 20% of the manufacturing articles, remaining being estimated from these

It was for this reason why there was such variance between the provisional data & the revised data

Among the more important recommendations of the committee were updating of the Base year from 1993-94 to 2004-05 & expanding the commodity number

The current WPI with 435 articles & Base year 1993-94 does not properly capture the current trend in the basket of goods

Service goods & items like mobiles which are now important are largely missing

An increase in the weightage of the manufactured articles in the WPI was also recommended

These proposals were criticized by RBI sensing that monitory policy would then become difficult to review

So for now the Cabinet is only implementing the periodicity change while saying that the other changes will follow soon

The govt.’s move may be a first definitive step in correcting the flaws of the WPI but the discrepancy b/w CPI & WPI remains

Kredent ANALYSIS – While the bureaucrats argue that the move is aimed at aligning our inflation reporting frequency with that followed by other major economies, market participants believe that the move is aimed at subduing the hysteria around inflation ahead of it attaining high levels

Author: Rahul Sonthalia, Analyst, Kredent Group

USD-INR Choppy and Uncertain

Markets continue to be volatile on the back of mixed trade signals both from the external and domestic economy. While the longer term outlook of India’s growth story and an appreciating Indian rupee remain intact, markets are probably taking a breather before resuming the ongoing trend.

Over the past month the USD/INR experienced excessive volatilities first dropping to lows of 45.80 in the first 8 days and then again bouncing off to test the 47.50 levels. Yesterday’s closing of 46.81 might suggest a revival of the downward trend for the rupee but outlook remains very uncertain with the indicators that the USD/INR pair feeds on not showing any clear signs.

Exchange Rates

Major pairs	29/09/2009	06/11/2009
EUR USD	1.4553/55	1.4879/82
GBP USD	1.5967/69	1.6607/11
USD JPY	89.92/94	90.64/65
USD INR	48.10/11	46.80/81
GBPINR	76.80/83	77.76/78
100JPY/INR	53.48/50	52.07/09
EURINR	69.99/70.02	69.49/52

Key International Indices and Commodities

Index	29/09/2009	06/11/2009
Dow.Lones	9789.36	10023.42
NASDAQ	2130	2112.44
SENSEX	17126.84	16158.28
NIFTY	5083.95	4796.15
FTSE	5133.25	5142.72
NIKKEI	10133.25	9789.35
GOLD	987.80	1092
OIL	64.63	78.51

Markets continued to remain volatile during the whole fortnight. After breaking 17000 in early October, Sensex lost close to 1500 points in 10 trading sessions to close under 16000. Other major currencies continue to be volatile on the backdrop of uncertainty prevailing in the markets. The Euro has not been able to break the 1.4900 resistance level and fell sharply after the adverse unemployment data at 10.2 % (highest in many years) and non farm payroll which also came adverse). While it remains to be seen what impact the adverse data will have on the market, there are two likely scenarios emerging out of the same.

Scenario 1- Rising unemployment in US will make investor rush to buying USD and reduce their exposure in risky assets. The price of gold has rallied to a new record high which may spark some concern of an impending bubble in a number of asset markets including gold. The first reaction as was evident in trading on 06^th Nov as the data came out was the weakening in the Euro and GBP which fell sharply before stabilizing in the later part of New York trade.

Scenario 2- The weak economic data also reduces the odds of Fed tightening in the near term and hence give an impetus to the Dollar carry trade to continue. This would add more shorts in USD. While this is likely to percolate to the USDINR, we need to trade cautiously.

Recent US data

October unemployment rose to 10.2% (Consensus- 9.9%) and nonfarm payrolls declined by 190K (Consensus- 175K).

The next week sees Initial Jobless Claims, Monthly Budget Statement (US) and Trade Balance figures coming out.

USD/INR Weekly outlook

Markets would continue to be choppy between 46.65 and 47.25 ranges. Markets would be closely being linked to the Asian Equities and Euro. Any weakening in the same might see shorts being covered and a move above the 47 levels.

USD/INR Choppy and Uncertain

R3:- 47.9900

R2:- 47.6200

R1:- 47.2362

Current Levels: – 46.81

S1:- 46.77

S2:- 46.35

S3:- 46.02

Indian Steel Sector – Results Update

• The recent recovery in industrial growth and in the real estate sector augurs well for Indian steel makers and the resultant rise in demand is already evident. India and China are two markets where steel units are operating at quite high levels of capacity utilization; 86% for China and 80% for India, compared with the world average of 64%.

• The four major steel companies came with their Q2FY10 results in October 2009. Tata Steel Ltd., India’s biggest producer, reported a nearly 50.0% slide in profit and state-run Steel Authority of India Ltd. posted a 17.0% decline in net income last quarter. Net profit of Jindal Steel &Power Ltd. And JSW Steel Ltd. improved by 7.5% and 42.2%, respectively

• Most companies benefited by selling more of their products as demand picked up because of the stimulus package and lower raw material prices but it did not translate into higher revenues and profits due to poor prices

• Indian steel prices fell almost 35.0% from a year earlier, trimming earnings at local steelmakers.

• Steel exports during the period declined by 40% to 0.93 million tonne as the global economy continues falters

• The steel companies have reduced the price of flat steel products on account of global weakening of prices and appreciation of the rupee, as well as a dip in Chinese domestic prices

• The margins have also contracted mainly on account of lower realizations and higher raw material prices

• We believe that the Steel Stocks have gone way above their fundamentals and most of the demand recovery and other such factors are already factored into their prices. Thus entering them at the current levels would be taking on significantly higher risk and so one should wait for at least 2 more quarters to see whether or not fundamentals improve and then enter

Result Update – Indian Steel Sector (Sept-09)

Overall Outlook of Steel Sector Companies