Indian School of Business: July 2007

Indian telecom companies added a whopping 7.34 mn users in June, 2007

The temporary slowdown in India’s celebrated telecom growth over the last couple of months due to government’s enforced verification drive is now history. The telecom sector is buzzing again—operators have added a record 7.34 million subscribers in June, the highest subscriber growth in a month so far, the country’s telecom regulator. More importantly, industry players also said that June’s growth in subscriber numbers was a global record. Going forward, the industry is also confident of maintaining the growth rate of 7 million plus new users per month.

GSM players accounted for over 71% of June’s record growth and contributed 5.2 million users to this fold while the CDMA operators added the rest. This has also resulted in the Indian cellular base crossing the 185-million mark.

However, despite record growth over the last 12 months, the fact is that less than 20% of the country’s 1.1 billion population own a telephone! “If the government extends its support in the form of good policy decisions, then the sector can increase the 7 million monthly figure to about 9 million,” said the spokesperson with a leading cellular operator.

Commenting on the record growth, the Association of Unified Service Providers of India’s general secretary S C Khana said, “The growth was driven by CDMA players who cut handset prices to less than Rs 1,000, forcing the GSM sector to follow suit. The competition that followed over the handset price wars resulted in record additions. With more cheap handsets set to come in, and as the network coverage increases especially in the C category circles, the growth rate will increase.”

A closer look at June’s figures tell an interesting story. At a time when all players are riding the cellular boom, public sector BSNL has registered negative growth in five of the 21 telecom circles where it offers services. The PSU added just 0.43 million new subscribers in June compared to 1.96 million additions by Bharti Airtel, 1.54 million by Vodafone-Essar and 1.2 million by Reliance Communications. At the same time, India’s largest cellular operator Bharti Airtel continues to outperform the industry—the company added 1.9 million users last month taking its total subscriber base to over 42 million.

While cellular growth is back on track, the broadband sector has failed to match the trend. Total broadband users totalled 2.52 million in June-end, with the addition of a mere 0.06 million new connections last month. Despite 2007 being declared as the Year of Broadband, the country has added just 0.47 million high speed internet users during the first six months of the year.

India had added a record 6.73 million subscribers in January this year, but the preceding months witnessed a slow down with growth remaining below the peak of 6 million per month for the next couple of months as the impact of stringent verification rules and capacity constraints began to show. This resulted in the subscriber additions falling to 5.96 million in February, 3.53 million in March and 5.38 in April, before picking up to touch 6.57 million in May.

Source:

Telcos add 7.34 m subscribers in June - The Economic Times - July 26, 2007

Mobile firms receive windfall on rupee appreciation

Indian telecom companies are likely to get a windfall of Rs 100-150 crore during their first quarter of the current fiscal. The unexpected profits are due to the rupee appreciation, which had a negative impact on IT companies.

According to analysts, the two major companies – Bharti Airtel and Reliance Communications -- are expected to rake in Rs 100-150 crore additional profits due to foreign exchange gains. For the Aditya Birla group company, Idea Cellular, the additional profit could be around the Rs 40-50 crore levels.

The telecom companies’ capital expenditure (capex) mainly goes into equipment imports for their expansion plans. The rupee appreciation would result in foreign exchange gains as the companies are paying in dollars. The Indian rupee started appreciating against the dollar from April, rising 7 per cent this year compared with the same period last year.

Says Sumit Modi of Emkay Shares, “The majority of the active components are imported by the operators for which they pay in dollars. Therefore, the operators would benefit from the rising rupee to the extent of capex on active components.”

Idea Cellular has posted a consolidated net profit of Rs 308 crore during the first quarter of this fiscal. The net profit during the previous quarter ended March 31 was Rs 133 crore. In the case of Bharti Airtel, the consolidated total revenues for the quarter ended June 30, 2007 of Rs. 5,905 crore grew by 53% and EBITDA of Rs. 2,447 crore grew by 63% on a year on year basis. Reliance Communications is yet to announce results.

The other side of the rising Rupee

The rupee appreciation which has effected badly on the margins of export-oriented software companies, it has benefited some of the sectors also. As the Indian currency's value against the dollar moved from Rs. 44 on March 30 this year to Rs. 41 on June 30, there are many companies whose profits swelled from the above appreciation (plese see the chart below).

The companies with major imports have benefited by reducing their import bill in rupee terms. Comapnies with sizeable dollar loans have also benefited as the difference between the estimated outgo and the actual interest paid is shown as net gains from exchange fluctuations. As per the study done by Business Standard, other income, swelled by foreign exchange gains, contributed 21.47 percent of the profit before tax of 331 comapnies (financial services companies are not studied here) in the first quarter of current fiscal - the highest in five quarters. This figure was only 13.11 percent in the quarter ended June last year. If we exclude other income, the growth of PBT of these companies falls below 20 percent, when compared to their reported growth rate of 32.90 percent in PBT.

Larsen & Tubro, for example, has $600 million worth of overseas loans in dollars and yen and reported nearly Rs. 134 crore in foreign exchange gains last quarter. Pharmaceutical company Ranbaxy Laboratories, which has dollar loans of $750 million and reported foreign exchange gains of almost Rs. 200 crores last quarter, has a natural hedge against a raising rupee. Even though it lost Rs. 40 crore in revaluation of receivables, the net gain was still Rs. 160 crores. Ranbaxy earns a large part of its revenues from its US operations. However, the loss on sales front on account of rising rupee is offset by gains on forward exchange contracts. The gain earned by Ranbaxy on forward exchange contracts is almost Rs. 70 crores.

Inflation rate rises to 4.41 percent for the week ended July 14, 2007

Higher food prices pushed up the inflation rate to 4.41 per cent, but analysts expect the Reserve Bank not to raise key rates when it reviews the monetary policy on July 31. The inflation rate based on wholesale prices index, the key measure of cost of living, is still within the central bank’s medium-term target of 4-4.5 per cent and annual target of 5 per cent for this fiscal.

Vegetables costlier

Among the primary articles, prices of vegetables rose sharply by 7 per cent during the week, while those of cereals rose by 0.9 per cent.Though inflation figures will have a bearing on the measures to be announced by the RBI to regulate money supply, analysts said inflation is within control and there was little chance of the banking regulator going for a rate hike. Finance Minister P Chidambaram had indicated last week that high crude oil and food prices did not necessarily mean that monetary policy would be tightened further. However, the ever rising cost of vegetables may be a cause of concern for the government. Vegetable prices soared seven per cent for the week ended July 14 registering the highest increase among all items. Last week too prices of vegetables had gone up by 4.4 per cent. WPI, on which inflation data is based, rose by 0.1 per cent to 212.9 per cent during the week compared to 212.6 per cent in the previous week.Prices of some food items, however, came down marginally. Fish-marine became cheaper by two per cent while urad prices declined by one per cent pulling down the overall price of pulses by 0.3 per cent during the week. In the non-food articles category, prices of fibre rose by 2.2 per cent.

Manufactured products

Among manufactured products, rates of rice and bran oil rose by three per cent each, while imported edible oil, groundnut oil, cottonseed oil and oil cakes became costlier by one percentage point each. However, the prices of sugar, jaggery and gingelly oil declined by one per cent. Prices of fruits fell by 0.9 per cent. Egg, meat and fish also became cheaper by 0.5 per cent each. Index of paper and paper products group rose by 0.1 per cent to 192.8 points from 192.7 points last week due to marginal rise in the prices of printing paper white.Inflation numbers for the week ended May 19 was revised to 5.30 per cent compared to the provisional figure of 5.06 per cent. This was done as WPI for the week stood at 212.4 points against the provisional figure of 211.9.

Rising rupee may hit IT hikes

This is a very good article published today in The Economic Times on the impact of rupee appreciation, which may become a permanent macro economic phenonmenon, on the pay hikes as well as on recruitment in Information Technology sector, which bore the brunt of rupee appreciation effecting the margins of IT companies. As already told, every 1 percent appreciation in rupee against US dollar, the margins of export oriented IT companies are effected to the extent of 35-50 basis points or 0.35 to 0.50 percent.

Is the IT party over? For the moment, it looks so. With the strong rupee impacting adversely the profits of ev

ery IT company, salary increments are expected to take a hit. And more of the salary is likely now to become part of the variable component, so that you get more only if you work more and perform better. “There is tremendous pressure to keep costs down,” says Venkat Shastry, partner in executive search firm Stanton Chase International.

“Over the next few quarters, I don’t see anybody providing for any serious salary increases or making corrections, even if that means higher attrition. It’s been madness in 3 to 10 years’ experience category in the past few years. That will taper down.”

Salary cost is by far the biggest component of cost, accounting for 45% of IT companies ’ costs and 40% of BPO costs. With many mid-size and small IT/BPO firms seeing a fall in profits in the Q1 of this fiscal, and most larger ones witnessing a sharp slowdown, varied options are being considered to keep the salary component under check or to get more work out of each employee. The pressure to do this is more so as Indian IT’s competitors like IBM, Accenture and EDS have not been impacted by rupee rise as much, given that they have only a fifth or less of their workforce in India. Says Gangapriya Chakraverti of Mercer India, “Variable pay will come up in a big way. Compensation related to productivity and contribution will take over. Companies will have to be careful about headcount. They will no longer have the luxury of maintaining a large talent pool that’s sitting idle.” Such pools are maintained to provide for attrition or to use in the event of the firm suddenly bagging a big project.

Adds Gautam Sinha, CEO of TVA Infotech, “The mid quartile which has been getting close to 15-20 % increments in compensation packages, will see tightening. Companies might not decrease the percentage of increment; instead they might link it to productivity and performance and downsize number of people being awarded raises. This is because companies are getting work and signing new deals. So they need the workforce to deliver the job. But they can afford to be choosy about who they want to appraise.”

Rupee’s rise is expected to hit BPO employees harder than IT. Unlike infotech, where 30% to 50% of employees work onsite and paid in dollars, in BPOs, 90% of the work is done in India and employees are paid in rupees. “Mid and senior level executives in BPOs have been getting increments of 14-20 %. I think that will come down to 8-15 %. Overall weighted average of increments used to be 7-8 %. That may be down to 4-5 %,” Vashistha says.

The Source : The Economic Times - July 23, 2007

Weekly Poll for the week ended 22-07-2007

From the last week, I have started a poll on major macro economic and sectoral issues relevant for Indian economy. Please feel free to express your opinion. The poll is on top of the right hand side of the side bar of the page. My first poll is on Indian Rupee appreciation. As expected, 50% of the respondents said that Rupee will appreciate further, but suject to RBI intervention. 33% of the respondents said that Rupee will appreciate sharply. Everybody is sure that the rupee will appreciate further, but differ on its degree. Thank you very much for the response. The snapshot of the poll

The effects of appreciating Indian Rupee in Q1 - A snapshot - Part 2

With more software companies announcing their Q1 results, the impact of rupee appreciation is clearly visible. Some more snippets on this issue.

Wipro, India's third largest IT firm, has weathered a strong rupee to protect its operating and net margins during the first quarter (Q1) of the fiscal year 2007-08. Though the rising rupee impacted the company's sequential operating margin by 250 basis points (0.25 percent) in Q1, a healthy revenue growth of 35 per cent in dollar terms ($726 million) year-on-year (YoY) by its flagship IT division enabled it to beat the guidance of $711 million. Admitting the adverse impact of a strong rupee on its margins, Wipro's chief financial officer (CFO) Suresh Senapaty said operational improvements helped the company to partially offset the pressure on profitability arising out of rupee appreciation and limit the decline in operating margin by 250 basis points quarter-on-quarter (QoQ).
The Hyderabad-based Satyam Computer Services Ltd., which is targeting to join the $2-billion league this fiscal, suffered a sequential slip of 3.88% in net profit for the first quarter ended June 30 to touch Rs 378.32 crore. On the year-on-year basis, the company posted an increase of 6.8% in net profit. The company did manage to put in place buffers to minimise the rupee shock. Although the impact of the rising rupee was to the tune of 400 basis points (bps), the company managed to restrict the impact to 64 bps. The company’s operating margins dropped by 64 bps in Q1 FY08 against the sequential quarter and 218 basis points when compared to the same quarter last year. The Indian currency has surged by nearly 7% against the dollar in the first quarter with every 1% rise shaving off 30 basis points at the operating margins level. Addressing the media, Satyam chief financial officer V Srinivas said, “In dollar terms, we have grown by 10% and rupee terms, the growth is 3%. The 7% difference represents the rupee impact. Revenue would have been higher by Rs 138 crore if the rupee impact was not there.” Explaining the various measures to stem the rude rupee shock, Mr Srinivas said, “Margins took a knock of 230 bps due to rupee, 100 bps on higher visa expenditure and 70 bps on restricted stock options. We could offset it by 330 bps on increased prices, higher offshoring and improved loading factor. The net margins impact was 64 bps.” Talking about forex management, Mr Srinivas said, “We have currently hedged over $750 million, bulk of which is under option-based contracts. Forward contracts account for only $175 million. But hedging does not help in improving operating margins. It only comes in handy to lower translational losses.” Currency hedging has helped Satyam bring down the translation loss to Rs 96 crore.

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Inflation remains unchanged at 4.27 percent

Inflation remained unchanged at the previous week's level of 4.27 per cent for the week ended July 7, despite a fall in prices of fruit and vegetables, poultry chicken, moong and masur, and some manufactured items.

The wholesale prices-base index stood at 4.83 per cent in the corresponding week a year ago. During the week, prices of fruits declined by over 16 per cent, while vegetables witnessed an increase of 4.4 per cent. However, fish marine, condiments and spices got dearer along with pulses like gram and arhar. Among the manufactured items, prices of imported edible oil, sugar, groundnut oil and few metal products like lead ingot, aluminium material increased.

RBI may retain interest rates, and may raise CRR

The Reserve Bank of India is likely to keep key interest rates unchanged in its quarterly review of credit policy on July 31, but may increase the requirement for banks to keep cash with it to absorb excess liquidity in the system, economists and industry players feel. "Inflation concerns have been mitigated and interest rates are at peak. However, the desire to mop up liquidity remains and a hike in cash reserve ratio cannot be ruled out," ABN Amro Country Executive (India) Romesh Sobti said.

After touching a 14-month low of 4.03 per cent, inflation has been on an upward trend on account of rising prices of food, especially vegetables. For the week ended June 30 and July 07, the wholesale price index stood at 4.27 per cent. Even at this level, the index is within RBI's limit of five per cent for this fiscal and medium term target of 4-4.5 per cent. On the other hand, there is ample liquidity in banking system. The overnight rate at which banks borrow from each other in the call money market has been below one per cent for sometime now. On July 13, the rate was 0.49 per cent. "I expect RBI to raise CRR in the policy review to manage liquidity," HDFC Bank chief economist Abheek Barua said.

Cash Reserve Ratio (CRR), the requirement for banks to keep a certain portion of their deposits with RBI, stands at 6.5 per cent. Between December 2006 and March 2007, the ratio was increased thrice by half a percentage point each, which sucked more than Rs 45,000 crore from the system. Barua said the advantage of a CRR hike was that it worked dynamically. While the initial impact is to absorb liquidity, it dampens the entire process of money creation that works through successive rounds of lending, he said.

Echoing similar views, Crisil Principal Economist D K Joshi said there was no need to change key lending rates, but a CRR hike was a possibility to rein in liquidity. Oriental Bank of Commerce executive director Allen C A Periera also said interest rates should be left unchanged for the time being.

Although economists and banking experts agreed that some action from the RBI to curb liquidity was due, they differed on the methodology it should adopt. Some experts said a CRR hike will be too much for the banking sector to take. Joshi also said instead of a CRR hike, the RBI might use another tool -- Monetary Stabilisation Scheme (MSS) -- more aggressively for liquidity management.

The RBI Governor, Y V Reddy, had recently said that taking into account high expansion of money supply worldwide, and given the monetary overhang of 2006-07, it was important to contain monetary expansion at around 17 per cent this fiscal, in consonance with the outlook on growth and inflation. High funds inflow, which is leading to excess liquidity, might see some moderation due to tightening of norms for external commercial borrowings by the government recently and pick up in credit offtake by August.

"In the given scenario there is no need for tinkering with the interest rate as well as CRR rate as inflation is low and credit demand has slowed down," Punjab National Bank executive director K Raghuraman said. MSS auction is a better option to manage liquidity since an increase in CRR could push up interest rates. This could lead to higher inflow of foreign funds as they would find Indian market more attractive. This would lead to further appreciation of Rupee, he said.

The Source: The Hindu - July 17, 2007

The effects of appreciating Indian Rupee in Q1 - A snapshot

The Indian Rupee appreciating against all major currencies including US Dollar. It has appreciated from a low of Rs. 45-46 a Dollar to almost Rs. 40-41 a dollar at present, an almost 11-12% appreciation. This appreciation has effected all industries, but the brunt is borne by I.T. Sector, Textile sector and leather industry.

Information Technology Sector

India's software exporters, like Infosys, TCS, Hexaware, derive much of their income in foreign currencies and see such a rise eroding rupee earnings. A majority of these firms provide services, primarily to the US followed by Europe and the rest of the world. But the rupee has appreciated across all major currencies during the quarter – 7.1 per cent against the US dollar, 4.8 per cent against the euro, and 5.8 per cent against the pound. It is estimated that each 1 percent rise in rupee against dollar effects the margin by 35-50 basis points or 0.35 to 0.5% of software companies whose major revenue is derived from software exports. Most of the software service oriented companies reported a 10-30 per cent dip in their net profit compared with the trailing quarter’s net profit figure. While a big IT major such as Tata Consultancy Services (TCS) could offset the rupee appreciation to some extent due to its hedging, the smaller players have not been as lucky. They have just about started to hedge against the rupee appreciation.

The 7% rupee appreciation against the US dollar during the first quarter ended June 30, 2007 took its toll on the revenues and margins of Infosys Technologies, India's second largest software exporter. “For the first time in as many years, an appreciating rupee had a 3.5% direct fallout on our operating margins. While a 13-15% increase in offshore wages and 5-6% hike in onsite salaries had an impact of 2.5%, higher visa costs contributed another 1% to the overall operational impact,” Infosys CFO V Balakrishnan said. He said Infosys was successful in neutralising the negative impact of a strong rupee by hedging against the US dollar (1.5%), increasing the utilisation rate (3%) and securing better pricing (1%) to the extent of 4%. "As a result, the impact was brought down to 3% on the operating margin. We had hedged $925 million to take forward cover at the conversion rate of Rs 40.58 per US dollar. We will increase the forward cover, if required, by hedging more. The rupee had also appreciated against euro by 4.9%, pound by 5.5% and other currencies during the quarter,” Balakrishnan pointed out.
Tata Consultancy Services, India's largest IT services exporter, posted solid revenue and profit growth in its first fiscal quarter despite the appreciation of the rupee and escalating wage costs. TCS said its use of a hedging policy to mitigate the fluctuations in the various currencies in which it bills is paying off, and it closed the quarter with $2.5bn in outstanding hedges. Another way in which the company is attempting to offset pressure on its margins is by increasing the prices it charges to existing clients when current deals come up for renewal. During the first quarter, pricing rose 0.6%, and said it was looking at a raise of between 3% to 5% on forthcoming renewals.
Indian software firm Hexaware Technologies Ltd. operating profit margins fell 2.8 percentage points in April-June quarter, primarily due to a rise in rupee's external value.
Software services firm Aztecsoft, which posted a near 63 per cent decline in profit for the first quarter ended June 30, said the sharp rupee appreciation had impacted its performance. "Rupee appreciation was the fundamental reason. However, our tight control on operation and hedging has enabled us to reduce the impact," Aztecsoft Managing Director V Sunderajan said. "The revenues were impacted by 6.8 per cent on account of unanticipated exchange rate variation. However, tight control over operations, better utilisation and favourable hedging ensured that the bottomline impact was limited to 1.2 per cent of revenues," the company said.
KPIT Cummins' profit as compared to the preceding quarter declined by 9.77 per cent due to the rupee appreciation and salary increments, a company statement said. The rupee appreciation has forced the company to revise its PAT guidance for FY08 downwards from around Rs 70 crore to around Rs 63-68 crore.

STRATEGY

To offset the rupee appreciation, the companies have managed to effect a hike in the billing rates by 3-8 per cent. They have also improved their employee utilisation rates, managed wage cost by hiring more freshers and are moving to other geographies, where the currency impact is lower. The traditional levers of utilisation, onsite-offshore mix, employee rotation and scale efficiencies should kick in, but with a lag, said ABN-Amro analysts. The key differentiator, they added, should be how quickly the companies manage costs.

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Manufacturing Sector

Textile exports declined by 6% in the April-June period of this fiscal because of an all-time rupee appreciation of 14%.
CII said its survey of textiles and apparel export companies in the last financial year revealed that there has been a decline in total revenue, operating income and profit margin to the tune of 7.9 per cent, 8.9 per cent and 7.9 per cent respectively. Further, there could be an erosion of profit margins to the extent of 10.4 percent during the next six months only on account of a stronger rupee,” it said. “If we add the impact of rise in interest rates on the profit margins, it is a further decline of another 1.5 percent,” it said.
Small- and medium-sized, export-oriented pharmaceutical companies are expecting a 5-10 per cent decline in their bottom line for the April-June period, owing to the rupee appreciation. The impact will be minimal on the larger companies such as Ranbaxy, Sun and Wockhardt, as they are fully hedged against the net exposure of the rupee in the international markets. “The effect of rupee appreciation will be severe on companies, which are primarily export-oriented. Any pharma or contract manufacturing firm, whose 60-70 per cent revenues come from foreign markets, will find its bottom line affected by around 10-12 per cent. The companies are unable to compensate for the losses due to the long-term contracts,” Venkat Jasti, managing director, Suven Life Sciences, said. Suven, a major Contract Research and Manufacturing Services (CRAMS) player, has most of its revenues from foreign contracts. However, major players are unfazed. “We have 10 production facilities outside the country that serve as automatic hedging towards rupee-dollar transactions,” a Ranbaxy spokesman said.
The National Manufacturing Competitive Council (NMCC) has expressed concerns over the impact of appreciating rupee on the manufacturing sector, especially small and medium enterprises (SMEs).

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PM's Panel is bullish on Indian economy but with caution

The Prime Minister’s Economic Advisory Council, headed by former Reserve Bank governor C Rangarajan has observed and also recommended following measures.

Riding an investment boom, the Indian economy will grow 9% in the current fiscal on top of last year’s 9.4% growth and price rise will be contained at 4%.
The economy’s managers will have to make some tough choices like curbing the inflow of external debt, allowing the rupee to appreciate further and removing “administrative and procedural impediments” to acquisitions abroad. It sees the external environment as still being benign and expects sustained investment to keep growth booming. The need to curb capital inflows comes from the mismatch between the current account deficit, which is seen at $17.4 billion, and surpluses on the capital account (nearly $58 billion). The excess inflow of foreign capital can make the rupee far too strong; managing this would mean jacking up money supply which could harden inflation and eventually interest rates. A sensible policy response is to allow all these three things to happen in moderate doses and to discourage external borrowing for rupee expenditure.
The council is not in favour of disrupting foreign equity investments. “Equity investment by its very nature is high risk and policy continuity is an essential element to initiate and maintain such flows. They cannot be turned on and off at will. However, on the debt side, there are some areas that can do with some scrutiny,” it said.
The panel suggested three instruments to face the strong capital flow: allowing the rupee to appreciate, sterilising capital inflows in excess of what can be absorbed into reserves without pushing money supply growth above 17.5%; and instituting a policy of encouraging capital outflow and discouraging external borrowing for rupee expenditure.
The report pegged farm growth at 2.5%; industrial output at 10.6%; and services at 10.4%. Mr Rangarajan cautioned that unless the farm and power sectors grow, the current rate of economic growth cannot be sustained. “Food security is an extremely important issue. Agriculture should be priority, as 60% people are dependent on it.”
The Council expects that there will be no unemployment by 2010, if not earlier. Whether people are satisfied with their remuneration or not is a different matter, panel's chairman C Rangarajan qualified promptly. "The unadjusted employment elasticity for the latest period (1999-2000 to 2004-05) is 0.48. Even after adjusting sectoral elasticities to lower figures, it is seen that with a GDP growth rate of 8%, by 2010 the workforce will become equal to the labour force. A stronger growth rate, which is quite possible, will take economy to this point even in a shorter period. Economic growth has been a major driving force in achieving higher level of employment," EAC's Economic Outlook 2007-08 said.

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China's economy to become third largest in the world by year-end

China’s economy grew so rapidly in the first half of 2007 that it is likely to overtake Germany as the world’s third-largest by the end of this year, behind the U.S. and Japan, analysts say. The release of January to June figures for Asia’s second biggest economy provides fresh evidence that Beijing’s economic braking measures have had little effect.

China’s sizzling economy expanded even faster than originally thought last year, with the government revising 2006

growth of gross domestic product (GDP) to 11.1 percent from 10.7 percent. Data released by China’s statistics bureau last week showed the economy was worth 21.09 trillion yuan in 2006, about $2.65 trillion based on last year’s average exchange rate of 7.97 yuan to the dollar, but its 2.5 percent growth rate was well below China's.

The revision puts China in striking distance of Europe’s largest economy within months. “With this upward revision, it is highly likely that China will bypass Germany to become the third-largest economy in the world in current US dollar terms by the end of this year,” said Hong Liang, an economist at Goldman Sachs. As per the Goldman Sach's Report titled "DreamingWith BRICs: The Path to 2050" and published in 2003, in US dollar terms, China could overtake Germany by 2007, Japan by 2015 and the US by 2039. These predictions are becoming a reality. According to the World Bank, Germany’s economy was worth 2.9 trillion dollars at the end of 2006. Economists expect GDP in the second quarter to near or equal its breathtaking January to March pace of 11.1 percent growth.

JPMorgan Chase Bank economist Wang Qian put the second-quarter acceleration at 10.6 percent, and said it would pick up speed in the second half of the year. “We don’t see any sector of the economy slowing down. It’s firing on all cylinders,” said Wang. The torrid pace of development means that China’s economic czars will once again have to devise fresh ways to prevent the export powerhouse from the kind of overheating that could trigger a slide into financial crisis. Regulators have already taken this year introduced a slew of piecemeal administrative measures to slow the economy, including two interest rate hikes, five increases in bank reserve requirements and new export curbs.

Exports, one of Beijing’s biggest headaches given the friction it causes with its two largest trade partners, the European Union and the United States, have continued to flood international markets. The widening trade gap is on route to becoming the globe’s largest ever after Beijing announced last week that its surplus had jumped more than 85 percent in June to $26.91 billion. Although the June figure was partly due to factories rushing to beat new curbs on exports that took effect July 1, the huge global demand for Chinese goods means the surplus will expand through the rest of the year, analysts said.

“China has become the world’s factory for manufactured consumer goods,” said Qu Hongbin, a senior economist at HSBC in Hong Kong. “If global consumer demand remains then Chinese exports will grow. There is not a lot that government policy can do about that.” Washington and Brussels believe one step to staunching the tide of Chinese goods would be greater appreciation in the currency, which trade partners say is artificially low and boosts China’s business competitiveness. But China’s autocratic leadership fears that could destabilise its financial system, making such a step highly unlikely, in keeping with the government’s repeated position of allowing the yuan to rise slowly. Earlier this month the nation’s top economic planner said China had to further tighten macroeconomic controls in the second half in the face of growing financial risks.

“The trend is of an economy that is moving from a bias of fast growth to overheating,” said a research arm of the National Development and Reform Commission. Li Huiyong, chief analyst at Shenyin Wanguo Securities in Shanghai, said the government had to get cracking. “At the moment, there is no obvious change to the overheated economy, with inflation and investment (levels) likely to jump,” said Li. “Under such circumstances, the major task is to prevent further overheating and strengthen controlling measures.”

In fact, a WallStret Journal report says China's imminent overtaking of Germany is only one instance of a broader global shift, according to the report. As populous countries such as China and India become major forces in the world economy, established powers such as Europe, Japan and the U.S. are becoming relatively less important, the Journal said. Many economists already argue that global growth is becoming less dependent on the U.S. economy, which has slowed in the past year without greatly affecting others, according to the report.

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Corporate Sector continues to shine: says CII State of the Economy report

CII released the July 2007 issue of 'State of the Economy' analysis for the last quarter-Q4 (Jan-March) results. According to the CII state of the Economy, the impressive performance of the Corporate sector is consistent and led by the Services sector. The July 2007 CII State of the Economy has surveyed and analyzed results of 3283 firms comprising 1971 firms from manufacturing and 1312 firms from services.

The highlights of the report are:-

Corporate Sector continues to shine led by Services . The impressive performance of Corporate Sector continued in the last quarter of the financial year 2006-07, showing consistency with the GDP growth rate of 9.1 per cent achieved in that quarter (Q4). On almost all the parameters, Corporate Sector is doing better during Q4 in comparison to the same quarter in the previous financial year.
The net sales has recorded a growth rate of 19.35 per cent in the fourth quarter (Q4) as compared to the growth rate of 17.86 per cent achieved during the same quarter in the financial year 2005-06. The profit after tax (PAT) has registered a significant increase in the growth from 13.68 per cent in Q4 of 2005-06 to 19.12 percent in Q4 of 2006-07, owing to a lower rate of growth in input cost and operating expenditures.
It is mainly the performance of the Services sector that has resulted in the overall increase in the profits growth of the corporate sector. The Services Sector has recorded a significant decline in the growth of operating expenditure from 16.33 per cent to 10.41 per cent while showing an increase in the growth rate in net sales from 16.48 per cent to 24.74 per cent.
Though the interest payments increased significantly showing a growth from 21.63 per cent to 47.68 per cent in Q4 of 2006-07, the Services sector companies have registered growth rate in profit after tax to the extent of 45.68 per cent against the growth in profit at the rate of 10.32 per cent in the Q4 of 2005-06. The growth rate of profit after tax of manufacturing has declined during the same period from 15.17 per cent to 7.91 per cent.
The report has also highlighted a distressing trend in the area of Agriculture - decrease in Oilseeds production. In fact, Oilseeds production, has registered a negative growth rate of 14.79 per cent. This is likely to lead to increase in the import of edible oil due to its reduced domestic production and rising demand. The demand is rising owing to the rising income levels and growing popularity of fast foods among the rich and upper middle class. Therefore, the CII State of the Economy Survey recommends that there is need to restructure domestic pricing policy of various crops as farmers are switching from oilseeds crops like mustard to more lucrative alternatives like wheat and gram.
The recently released Index of Industrial Production which has shown declining growth rate for manufacturing to 11.9 per cent in May 2007 from 15.1 per cent in April 2007 is in line with the warning given in this issue of the State of the Economy about the lagged effect of the increase in interest rate. The dip stick survey done by CII on behalf of National Manufacturing Competitive Council (NMCC) to assess the impact of the rise in interest rates had reported negative impact on business due to the increase in cost of financing.
The 'CII State of the Economy' also reports the negative impact of appreciating rupee on profit margins of textile and leather sectors. The CII survey of textiles and apparel companies engaged in exports revealed that there has been a decline in total revenue, operating income and profit margin to the tune of 7.9 per cent, 8.9 per cent and 7.9 per cent respectively and further, there could be an erosion of profit margins to the extent of 10.4 per cent during the next six months only on account of appreciation of the rupee. If the impact of rise in interest rates on the profit margin is also considered, then it is a further decline of another 1.5 per cent. The impact of the appreciation is worse in the leather and leather products sector. The erosion of profits expected in the next six months is 13.7 per cent and the industry is already facing an erosion of 8.8 per cent on its profit margin.
On the whole, the CII State of the Economy expects the GDP growth to be 9.2 percent during 2007-08; with Agriculture growing at 3 percent, Industry at 9.4 percent and Services at 11.2 percent.

Source: The website of CII

Complete Report :-

State of the Economy - July, 2007

Rising rupee will continue to hit the bottomlines of I.T. companies

A strong rupee is likely to lop Rs 1,000 cr off blue-chip IT company Infosys Technologies’ topline in FY08. Though Infosys witnessed a healthy 7.5% sequential growth in top line in dollar terms , the hardening rupee took the sheen off its performance. Infosys reported a 5.7%sequential decline in consolidated net profit, which stood at Rs 1,079 crore in the first quarter (Q1) ended June 30, 2007, against Rs 1,144 crore in the fourth quarter (Q4) ended March 31, 2007. The appreciating rupee has taken away Rs 287 crore in Q1 from Infosys, besides enquring that it misses its quarterly guidance for the second time running. “Infosys will have to maintage the appreciating rupee with higher volume growth,” said CEO & MD Kris Gopalakrishnan.

So is it the end of the euphoric times that the Indian IT sector has been getting used to — and all because of the relentless appreciation of the rupee against major currencies. The answer seems to be yes, given the fact that the Indian IT sector earns four out of every five rupees from overseas clients and that most IT exporters’ margins are being squeezed on account of stronger home currency. However, the picture is not all that sombre as there are still some sons of the soil, that have significant India operations in the highly export-oriented IT industry. ETIG has taken a closer look at some of the companies that generate sizeable revenue by serving the domestic market. These companies run operations in India profitably. They are shielded from the currency fluctuations to a great extent as only a small portion of their income is earned in foreign currency. Tulip IT Services, CMC, NIIT and Spanco are among them. While Tulip earns all of its revenue domestically, the others generate more than three-fourth of their total income from India. Larger firms like Ramco Systems and Rolta India have about two-third of revenue coming from the domestic clients. IT companies in India have traditionally looked westward for business. This was probably because the domestic market appears to be a tiny dot compared to the larger opportunities globally. Nasscom estimates the global IT market for Indian IT companies to be $45 billion.

There is something puzzling about how the government appears to be thinking about policies relating to capital inflows and the rupee. On the one hand, it is going all out to attract more foreign capital inflows and is also encouraging overseas borrowing by Indian companies. On the other hand, it now appears undecided about whether or not to allow further significant appreciation of the rupee against the dollar, a highly likely outcome if net capital inflows continue to surge. The rupee has gained more than 9 percent against the dollar since the start of the year, and touched a nine-year high of 40.28 rupees per dollar in late May. Its surge triggered complaints from small and medium-sized exporters, which account for 45 percent of the country's exports.

It is hard to fathom that April's uncharacteristically huge appreciation of the rupee against the dollar was solely the RBI's decision. It is equally hard to imagine that the central bank's return to intervention in the foreign exchange market in recent weeks is without the government's sign-off, or perhaps the intervention is at the government's suggestion.

Ambit Capital has come out with report on rupee appreciation impact on IT sector. They say every one percent Rupee appreciation could hit IT sector EBITDA margins by 40-60bps or 0.4 - 0.6%.

At the end, we have to realise that the rupee appreciation is going to stay. Many analysts say that the Rupee could appreciate upto a lvel of Rs. 35-37 per one Dollar by the end of 2007. Of course, if the government does not take any measures to reduce FII inflows, the above scenario may become a reality. As Infosys chairman and chief mentor N.R. Narayna Murthy has said, the rupee appreciation was a macro economic issue and called upon corporates to become more efficient, productive and reduce costs in operations. This meant that the revenue generated per employee in I.T. sector would have to be improved. Is this an indication of lower level of growth in employment in IT sector or lower wage increase in the IT sector?

In this respect, I would request the viewers to read the reports of Goldman Sachs, an international consulting firm, on emerging economic super powers of tomorrow - BRICs (Brazil, Russia, India, and China).

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Inflation rises further to 4.27 percent

India's inflation unexpectedly accelerated in the last week of June as prices of cereals, pulses and other food products rose. The index of food articles rose 0.7 percent in the week to June 30, compared with a 0.3 percent gain in the index of manufactured products. The wholesale price index rose 4.27 percent in the week to June 30 from a year earlier, compared with 4.13 percent in the previous week. The government revised the inflation rate for the week ended May 5 to 5.74 percent from 5.44 percent. The government revises the inflation rate after a delay of two months on additional price data.

Prices of manufactured goods rose at half the pace of food costs, increasing optimism the central bank may refrain from lifting interest rates this month. Farm prices may decline as the government this month awarded contracts to import more wheat and as farmers planted oilseed and other crops in a larger area this year, boosting supplies. ''Food prices will come off after monsoon crops arrive and increase supplies,'' said Mini Uboveja, an economist at STCI Primary Dealer Ltd. in Mumbai. ''Raising interest rates won't help in checking food prices.''

Reserve Bank of India Governor Yaga Venugopal Reddy will set interest rates in his next monetary policy statement on July 31. Reddy has raised the central bank's key repurchase rate, or the overnight lending rate, six times in the past 1 1/2 years to slow loans and contain manufactured product prices. The Reserve Bank has allowed to rupee to surge to near a nine-year high to make imports cheaper and contain inflation. The central bank has slowed dollar purchases on concern that rupee funds injected from intervention will stoke inflation. The rupee fell 0.1 percent to 40.48 per dollar this week as of 1:15 p.m. in Mumbai, according to data compiled by Bloomberg. The currency has gained 9.4 percent this year, more than five times its advance in 2006.

The new National Mineral Policy is claered by GoM

A Group of Ministers (GoM) cleared the national mineral policy that retains freedom of mining comapnies to export iron ore without any restrictions on quantity or quality. The policy would be sent to the Cabinet for approval.

There is a difference of opinion on iron ore exports between mining and steel industry. While the steel industry supported a cap on iron ore exports to meet the requirement of the growing domestic steel industry, the mining industry favoured unrestricted exports citing comfortable reserve position on iron ore. The domestic steel manufacturers fear that if all the proposed steel plants come in India, some will be deprived of iron ore and if free exports of iron ore are allowed, then prices also go up making the cost of making steel much higher.

The highlights of the proposed national mineral policy are

It has been decided to give free hand to companies to export iron ore without any restrictions on quantity or quality
It has been decided to provide captive mines to all steel units in operation up to July, 2006
As part of policy, a process of competitive bidding could be intiated for allocation of captive coal blocks
The new policy gives more powers to states to facilitate value addition within the country and give a boost to steel production. the state governments would be able to give preference to companies undertaking value addition within the state while alloting iron ore mines. This would mean that stand-alone mining activities would be disincentivised.
The entire country would be treated as one economic region and states would have to permit transfer of iron ore outside the state if no one is willing to set up a plant there.
While approving the policy, the GoM has reatined most of the recommendations of the Hoda Committee.
The policy is mainly aimed at procedural simplication for attracting investments in the sector. It would also benefit the states, as under the new policy, the present system of specific rate royalty would shift to an ad valoreum rate of 7.5 percent. This move would increase the royalty earnings of ths states by almost six times.

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Is Small Bazaar replacing Big Bazaar in retail food chains in India

Pantaloon's Kishore Biyani is bringing his new stores - call it 'Small Bazaar' - , which will be small, like Subhiksha, which is a convenience store format and will look to address the daily shopping needs of consumers. For the past 18 months, Pantaloon has ben working on new project for the launch of KB's Fairprice Value Stores (KBFVS), a no-frills, deep discount format, sometime in August that will focus on local catchment areas and service the daily requirements of consumers. This is a radically different concept and services model which is based on a German no-frills discount format, LIDL (Owned by Schwarz). Pantaloon is planning a 'bombardment strategy' that will see the group swarming a particular area with clusters of stores. The group plans to set up 1500 stores over 18 months across top cities.

These non-ac, basic format stores will offer limited stock-keeping units with massive discounts, but will not compete with kiranas. The launch is also the result of consumer learning that

Indians prefer fresh supplies and proximity of stores in residential areas to make frequent purchases
More often than not, indian consumers do not have access to good roads, cheap fuel or have large storage space to stock up the bug volume purchases
the traditional kirana style is best suited to the Indian consumer's needs

In fact, most of the modern food retailers have recently begun following the kirana (local mom-'n'-pop stores) business strategy of setting up smaller convenience food and grocery stores. These stores have positioned themselves as upscale kiranas with back-end efficiencies of a large retailer, new format such as Trumart. Spencers Daily, Wadhwani's Spinach, Vishal, D Mart and others are offering the kirana convenience of being situated locally and offering similar services such as taking orders over phone and making home deliveries.

Change in Strategy

Earlier, most of them had set up stores in the larger format hoping a higher conversion rate (consumers actually making purchases) from the footfalls in these farmats, a strategy which did not prove too profitable. Retailers say most consumers tend to visit these areas as entertainment zones rather than making their daily basic grocery purchases.

Convenience store formats are also able to get better bargains with suppliers and manufacturers by offering business scales higher than the local kirana. Consequently, manufacturers have begun stepping up discounts to the new formats, industry players said to ET.

Kishore Biyani - In Brief

Biyani, 45, is CEO, Future Group, which is designed to cater to the entire Indian consumption space. After graduating in commerce, Biyani joined the family textiles business. Five years later he launched the first branded ready-made trouser, called Pantaloon, marketed through The Pantaloon Shoppe.

Founded in 1987, as a garment manufacturing company, Pantaloon entered modern retail in 1997 with the opening of a chain of department stores, Pantaloons.

In 2001,

Biyani evolved a pan-Indian, class-less model — Big Bazaar, a hypermarket chain, leading to the democratisation of shopping in India. With Food Bazaar, a supermarket chain, he blended the look, touch and feel of Indian bazaars with western hygiene and it has now evolved into the favoured destination for Indian homemakers. The Future Group operates through six verticals: Future Retail (encompassing all lines of retail business), Future Capital (financial products and services), Future Brands (all brands owned or managed by group companies), Future Space (management of retail real estate), Future Logistics (management of supply chain and distribution) and Future Media (development and management of retail media spaces).

The group's flagship enterprise, Pantaloon Retail, is India's leading retail company with presence in food, fashion and footwear, home solutions and consumer electronics, books and music, health, wellness and beauty, general merchandise, communication products, e-tailing and leisure, and entertainment.

Inflation up at 4.13 percent

After going down for twelve consecutive weeks, the inflation rate again moved upwards for the week ended June 23, 2007 at 4.13 percent , as against 4.03 for the previous week. The rise in inflation is mainly due to the increase in some food and mineral prices. this is the fifth week that onflation has remained below the 5% mark. the govenment is working on fiscal and monetary policies to keep inflation within 5 percent.

Caution:-

High prices of wheat and crude in the international market could exert upward pressure on the inflation rate
Any upward revision in fuel prices by the government, to bring domestic fuel prices in line with the gobal trend, could push up inflation

Related Reports:-

Review for the week ended 23rd June 2007 - CSO

Non-Food credit falls for the first time after six years

The doomsayers of Indian economy saying that the economy is overheating get an answer in the non-food credit take off in the first quarter of the financial year 2007 from April-June, 2007. Latest RBI figures reveal that aggregate non-food credit extended by banks declined by Rs. 30,352 Crores between April and June 22 to Rs. 18,17,955 Crore. For the first time after six years, the non food credit growth is heading towards south. Though a slow credit demand is normal in the first quarter, the lean season, for the first time in 24 quarters, banks are seeing their loan portfolio shrink. Significantly, it is happening when deposits parked in banks are recording the highest quarterly growth of over Rs. 1,00,000 crores, thanks to the aggressive methods followed by various banks to attract meidum term fixed deposits.

The RBI has taken various measures like interest rate hikes, give directions to the banks to rate the exposure to the real estate and reatail sector as high risk area, making the real estate and retail sectors difficult to get the bank loans and even if they get, at a premium interest rates. All these measures have an impact in the form of decline in credit off take. These measures are mainly aimed at containing the inflation and also avoiding any bubble in the real estate sector which will have dangerous consequences on over all health of the economy.

But, many bankers feel that the decline is a temporary phenomenon. With the start of busy credit season coming, with many companies looking at expansion and acuisitions, and also with the recently goverment cleared SEZ proposals, the credit growth may see north wards from the next quarter.

Related Articles:-

RBI's efforts for economy showing results - The Economic Times - July 06, 2007

ISB alumni launch online taxfiling site TaxYantra.com

On invitation, I accompanied my Chief Commissioner of Income Tax, Sri D. V. Dharmik, who along with Dr. Rammohan Rao, Dean, ISB launched today the online tax filing portal TaxYantra started by a group of four Indian School of Business (ISB) alumni at Hyderabad. This is supposed to be India's first customised online tax filing service for Indian citizens in the country and abroad.The web-based solution created by TaxYantra enables the tax payer to understand taxes and fill the tax return forms online. The print outs of these forms will be picked up by the representatives of the company and file with the Income Tax department. To start with the company intends to charge Rs. 100 for online return and Rs. 250 if the manual filing is also involved.

"Our website has received about 50,000 hits in the last couple of days, and a quarter of them have been from Hyderabad and Bangalore," Nitin Vyakaranam, founder and director, TaxYantra, said. According to their survey, individual income tax assessees spend, on an average, five hours on filing returns by way of meeting HR personnel, consultants and waiting in queue at the Income Tax office.

The four partners, including Nitin, together invested Rs 50 lakh in the initiative. They plan to offer a few other financial services to clients. Nitin said the company was also ready to directly send the tax return filings online to the department once the authorities decide to accept forms in the extensible markup language (XML) format. Mr. D V Dharmik, Chief Commissioner, Income Tax department, said that prsently filing return online is compulsory for the comapnies. However, it is not mandatory for individuals. He said that it may not be far away before which the Department introduces the seamless form of receiving returns, processing and issuing refunds, without the intervention of humans anywhere in the process, thereby reducing contact between the Deaprtment and the taxpayers. The efforts on the lines of TaxYantra will go a long way top educate tax payers in respect of income tax procedures and filing their tax returns in time.

Mr. Rammohan Rao, dean of ISB, said that many of the ISB alumni are becoming entrepreneurs. As per the details availbale, 38 students of the recently passed out batch have started their own ventures excluding the students who have business background before joining ISB. In this regard, he lauded the efforts of Wadhawani Centre for Entrpreneurship in ISB and also thanked Wadhwani Foundation, who has been sponsoring the entrepreneur initiative taken by ISB. He further added that the institute's endeavour was to churn out more job creators rather than job-seekers. He also felt very happy that such initiatives are increasing day by day. Many of ISB alimni attended the inauguaral function.

Related Reports:-

ISB alumni start online tax filing service - Business Standard - 03-07-2007

RBI is upbeat on economy but warns of credit slowing down

The follwing is the summary of speech of Dr. Y. V. Reddy, RBI Governor at Ignatiev of Bank of Russia.

From an annual average growth rate of 3.5 per cent during 1950 to 1980, the growth rate of the Indian economy accelerated to around 6.0 per cent in the 1980s and 1990s. In the last four years (2003-04 to 2006-07), the Indian economy grew by 8.6 per cent. In 2005-06 and 2006-07, it had grown at a higher rate of 9.0 and 9.4 per cent, respectively. There is, thus, tangible evidence of self-accelerating growth.
An important characteristic of the high growth phase of over a quarter of century is resilience to shocks and considerable amount of stability. We have witnessed one serious balance of payments crisis triggered largely by the Gulf war in the early 1990s. Credible macroeconomic structural and stabilization programme was undertaken in the wake of the crisis. The Indian economy in later years, could successfully avoid any adverse contagion impact of shocks from the East Asian crisis, sanction like situation in post-Pokhran scenario, and border conflict during May-June 1999. Seen in this context, this robust macroeconomic performance, in the face of recent oil as well as food shocks, demonstrates the vibrance and resilience of the Indian economy.
The average saving rate in India was 10 per cent in the 1950s, which rose to 17.5 per cent in the 1970s and further to 23.4 per cent in the 1990s. The saving rate was 32.4 per cent in 2005-06. The strengthening of economic activity in the recent years has been supported by persistent increase in gross domestic investment rates from 22.9 per cent of GDP in 2001-02 to 33.8 per cent in 2005-06. It may also be noted that over 95 per cent of investment in the country during this period was financed by the domestic savings.
On the price stability front, India's performance has been fairly good. Since independence, the inflation rate, in terms of the wholesale price index (WPI), on an average basis, was above 15 per cent in only five out of fifty years. In thirty-six out of fifty years, inflation was in single digit and on most occasions high inflation was due to shocks – food or oil. The tolerance level to inflation has been low, relative to many developing countries, especially on account of the democratic pressures in the country.
The inflation rate accelerated steadily from an annual average of 1.7 per cent during the 1950s to 6.4 percent during the 1960s and further to 9.0 per cent in the 1970s before easing marginally to 8.0 per cent in the 1980s. However, the inflation rate declined from an average of 11.0 per cent during 1990-95 to 5.3 per cent during the second half of the 1990s (1995-2000) and further to 4.9 per cent during 2003-07. More recently during 2006-07, WPI based inflation rate increased from 4.1 per cent at the end of March 2006 to an intra-year peak of 6.7 per cent at end-January 2007 and remained firm in the range of 6.1-6.6 per cent in the succeeding weeks before moderating to 5.9 per cent by the end of the financial year (i.e., as on March 31, 2007). Since then, the inflation has further moderated and as on June 16, 2007, the WPI inflation rate was 4.0 per cent.
In recent period, there has been considerable improvement in the fiscal position. The average gross fiscal deficit of the central government as per cent to GDP during the decade of 1980s was 6.8 per cent as against 3.8 per cent in the 1970s. The Government of India is pursuing the path of rule-based fiscal consolidation from the year 2004-05 under the Fiscal Responsibility and Budget Management Act, 2003 whereunder time-specific targets have been mandated. The underlying purpose of the targets is to reduce the ratio of gross fiscal deficit (GFD) to gross domestic product (GDP) to three per cent by 2008-09. Furthermore, the revenue deficit (RD) to GDP ratio has been targeted to touch 0.0 per cent by 2008-09 so that borrowed resources can be used to meet only capital expenditures. The progress of targeted fiscal consolidation has been satisfactory so far and GFD/GDP and RD/GDP ratios are budgeted to reduce to 3.3 per cent and 1.5 per cent, respectively, in 2007-08. The objective is to meet the targets under the Fiscal Responsibility Act by 2008-09.
The average current account deficit since 1950-51 has been around one per cent of the GDP. During this period, except for 11 years when there was marginal surplus in the current account, we had modest deficit during the rest of the years. In the aftermath of the balance of payment crisis in the early 1990s, several stabilisation and structural reform measures were undertaken.
External sector indicators show considerable level of sustainability attained in the last decade. Sustained growth in export of services and remittances has continued to provide buoyancy to the surplus in the invisible account, which has enabled financing a large part of trade deficit. The capital flows have been buoyant leading to sustained rise in foreign exchange reserves. The merchandise trade deficit is currently close to 7.0 per cent of GDP; however, the current account deficit is under 1.5 per cent of GDP, mainly due to receipts from services and the steady support from remittances from Indians working abroad

Prospects of Indian Economy

In terms of immediate prospects, overall, we expect the real GDP growth in 2007-08 to be around 8.5 per cent, assuming no further escalation in international crude prices and barring domestic or external shocks. For the year 2007-08, the Reserve Bank's policy endeavour would be to contain inflation close to 5.0 per cent. In the medium term, in recognition of India’s evolving integration with the global economy and societal preferences, the resolve, going forward, is to condition policy and expectations for inflation in the range of 4.0–4.5 per cent.
The acceleration of growth in the real sector has been reflected in the upward shift in the growth trajectory of credit extended by commercial banks, which in the past three years has been unprecedented in the history of the Indian economy. There has been some sign of deceleration in the recent period.
In consonance with the rising capital flows, the reserve money growth has been higher in the recent period averaging 17.8 per cent during 2003-07. The rate of growth of reserve money was 23.0 per cent as on June 22, 2007 on year on year basis (18.2 per cent a year ago).
Similarly, the high credit growth in the recent period has led the money supply growth to remain high averaging 16.8 per cent during 2003-07. During 2006-07, the money supply grew by 21.3 per cent. As on June 8, 2007, the growth in money supply on year on year basis was 21.0 per cent (18.5 per cent a year ago).
Taking into account the high expansion of money supply worldwide, and given the monetary overhang of 2005-07, it is important to contain monetary expansion in 2007-08 at around 17.0-17.5 per cent, in consonance with the outlook on growth and inflation. The Annual Policy Statement for the year 2007-08 also placed aggregate deposits growth in 2007-08 at around Rs.4,900 billion and a graduated deceleration of non-food credit to 24.0-25.0 per cent in 2007-08.
For the medium term, the Approach Paper for the Eleventh Five Year Plan (2007-08 to 2011-12) targets an average annual growth of 9 per cent relative to 8 per cent targeted by the Tenth Plan (2002-03 to 2006-07). This aspiration for growth would require significant acceleration in investment from 27.8 per cent in the Tenth Five Year Plan to 35.1 per cent in the Eleventh Five Year Plan.
Realising that the growth benefits need to trickle down further, the Eleventh Five-Year Plan is likely to provide an opportunity to restructure policies to achieve a new vision based on faster, more broad-based and inclusive growth. Doubling of agricultural GDP growth to around 4 per cent is particularly important in this context. The Approach Paper suggests that this must be combined with policies to promote rapid growth in non-agricultural employment so as to create 70 million job opportunities in the 11th Plan.
Very recently on May 29, 2007, our Honourable Prime Minister announced a major scheme to double the growth rate of agriculture to 4.0 per cent over the 11th Plan period. The Government would provide rupees 250 billion for new farm initiatives launched by States. A time-bound Food Security Mission was also announced to counter rising prices of food products and to ensure visible changes in their availability over three years.
If these objectives are achieved, the percentage of people in poverty could be reduced by 10 percentage points by the end of the Plan period. The policy reforms and monitorable targets as indicated in the Approach Paper, particularly on education, health, women and children, infrastructure, when attained, are expected to benefit a larger chunk of population immensely. This will help in making the Indian growth process more inclusive and durable.

Financial Sector

The Indian financial system of the pre-reform period, before 1991, essentially catered to the needs of planned development in a mixed-economy framework, where the Government sector had a predominant role in economic activity. Interest rates on Government securities were artificially pegged at low levels, which were unrelated to the market conditions. The system of administered interest rates was characterised by detailed prescriptions on the lending and the deposit side, leading to multiplicity and complexity of interest rates. As would be expected, the environment in the financial sector in those years was characterised by segmented and underdeveloped financial markets coupled with paucity of financial instruments. Consequently, by the end of the eighties, directed and concessional availability of bank credit to certain sectors adversely affected the viability and profitability of banks. Thus, the transactions between the de facto joint balance sheet of the Government, the Reserve Bank and the commercial banks were governed by fiscal priorities rather than sound principles of financial management and commercial viability. It was then recognised that this approach, which, conceptually, sought to enhance efficiency through a co-ordinated approach, actually led to loss of transparency, accountability and incentive to seek efficiency.

Development of Financial Markets

Financial markets in India in the period before the early 1990s as I mentioned earlier were marked by administered interest rates, quantitative ceilings, statutory pre-emptions, captive market for government securities, excessive reliance on central bank financing, pegged exchange rate, and current and capital account restrictions. As a result of various reforms, the financial markets have now transited to a regime characterised by market-determined interest and exchange rates, price-based instruments of monetary policy, current account convertibility, phased capital account liberalisation and auction-based system in the government securities market. A noteworthy feature is that the government securities and corporate debt markets are essentially domestically driven since Foreign Institutional Investor and non-resident participation in these markets are limited and subjected to prudential ceilings.
The Reserve Bank has taken a proactive role in the development of financial markets. Development of these markets has been done in a calibrated, sequenced and careful manner such that these developments are in step with those in other markets in the real sector. The sequencing has also been informed by the need to develop market infrastructure, technology and capabilities of market participants and financial institutions in a consistent manner.
The Reserve Bank has accorded priority to the development of the money market as it is the key link in the transmission mechanism of monetary policy to financial markets and finally, to the real economy. The Reserve Bank has special interest in the development of government securities market as it also plays a key role in the effective transmission of monetary policy impulses in a deregulated environment.
A qualitative change was brought about in the legal framework by the enactment of the Foreign Exchange Management Act (FEMA) in June 2000 by which the objectives of regulation have been redefined as facilitating trade and payments as well as orderly development and functioning of foreign exchange market in India. The legal framework envisages both the developmental dimension and orderliness or stability. The legislation provides power to the government to re-impose controls if public interest warrants it. The Reserve Bank has undertaken various measures towards development of spot as well as forward segments of foreign exchange market. Market participants have also been provided with greater flexibility to undertake foreign exchange operations and manage their risks.
Linkage between the money, government securities and forex markets has been established and is growing. The price discovery in the primary market is more credible than before and secondary markets have acquired greater depth and liquidity. The number of instruments and participants has increased in all the markets, the most impressive being the government securities market. The institutional and technological infrastructure has been created by the Reserve Bank to enable transparency in operations and to provide secured payment and settlement systems.

Current challenges

In assessing short-term prospects, say for 2007-08, it is essential to recognise that the impressive growth in GDP at 9.4 per cent during the preceding year, reflects the contribution of both – the structural and the cyclical factors though their relative contribution is somewhat non-quantifiable. The critical task before the public policy, in general, and Reserve Bank of India, in particular, is to strengthen the structural factors in the economy but determinedly moderate the cyclical and excessively volatile elements of the economy.
There are reasonable grounds for optimism in regard to the prospects for Indian economy, and this has been globally recognised. However, it is necessary to remain guarded in matters relating to economic growth and stability of an emerging market economy in the current global environment of high output-growth, notable inflation pressures, persisting global imbalances, incipient signs of re-pricing of risks, and perceived volatility of capital flows.
We do recognise that relative to most large emerging market economies, we have several significant economic strengths but we also have twin deficits – current and fiscal; have a higher component of more volatile portfolio flows on capital account, and severe policy challenges in managing capital flows.
In view of the proven success of our overall approach to reform over the last fifteen years, there is considerable merit in pursuing the gradualist, participative and harmonious approach towards further reforms in financial and external sectors. Since it is generally accepted that financial and external sectors in India are reasonably strong and resilient, high priority is being accorded for further reforms in fiscal sector, agriculture, physical infrastructure, especially in power and urban areas, and delivery of public services such as water, health and education. Progress in these sectors will help, over the medium term, enhance competitiveness and accelerated reforms in financial and external sectors, in a harmonious and non-disruptive manner, thus, reinforcing self -accelerating growth with assured stability.

Complete Speech:-

Glimpses of Indian Economy and its Financial Sector - Dr. Y.V. Reddy, RBI Governer - 02-07-2007

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