Storm clouds over Indian market grow darker

The going will get harder for Indian shares this week as soaring inflation raises the prospect of higher interest rates, which could burn a hole in the pockets of consumers, slow down demand and hurt corporate earnings.

Throw in volatile commodity prices and the outlook gets more worrisome. With fears the global credit crisis could worsen there is little comfort for investors, who have already suffered big losses this year.

The risk of a downside is making investors nervous and many funds are sitting on cash. Large investors have moved to the sidelines on mounting expectation that shares will decline in the near term and throw up opportunities for bargain hunting.


Annual wholesale price-based inflation (WPI) in early August shot up to 12.6 per cent, the most in 16 years, strengthening fears the Reserve Bank of India (RBI) will hike interest rates and tighten money supply again.

Sonal Varma, economist at Leh-man Brothers in Mumbai said that the final WPI inflation to peak in October-November at around 13.5-14.0 per cent, but to stay above 10 per cent until February 2009.
A steep increase in salaries for some five million civil servants announced this month, ahead of national elections due by May, is expected to fuel inflation.

"The whole objective of monetary policy at this point in time, which is to contain and manage demand, is going to face hurdles," said Shubhada Rao, an economist with Yes Bank. "The pay revision is going to add to demand pressures on inflation."

Last week, New Delhi-based National Council for Applied Economic Research (NCAER) cut its outlook for economic growth to 7.8 per cent in 2008-09, saying high inflation and a global slowdown were major threats. In its forecast in May, the economic think-tank had forecast growth of 8.5-8.8 per cent.

Forecast revision

A week earlier, the prime minister's economic advisory panel had lowered its growth forecast to 7.7 per cent, slower than 9 per cent expansion in 2007-08. Last month, the RBI pegged down its growth projection to 8 per cent from 8-8.5 per cent forecast earlier.

"The brakes on growth have been brought about by the slowdown in global growth and high inflation," NCAER said in a report.

It said industrial output growth was expected to moderate to 8.4 per cent in 2008-09 from 8.6 per cent of last year, while farm output growth would slow to 2.5 per cent from 4.5 per cent. Services sector was seen up 9.1 per cent, slower than 10.8 per cent of last year.

Foreign funds, which usually set the trend for the stock market, have been voting with their feet as the economic situation worsens. Overseas portfolio investors dumped shares worth $775 million over the past six days, data from the Securities and Exchange Board of India showed.

D'Souza said the withdrawals were likely to pick up momentum and push the market down this week, with the expiry of monthly derivatives contracts on Thursday making prices more volatile.

The Sensex fell 2.2 per cent last week to 14,401.49, its second weekly drop in a row. The marker has dropped 29 per cent this year, with foreign funds pulling out $7.2 billion during the period.

Crude oil's 5.4 per cent slide on Friday, the biggest single-day tumble in four years, to about $114.6 a barrel should bolster sentiment when trading starts tomorrow, but the sharp swings will keep investors cautious, D'Souza said.

Although oil prices have dropped more than a fifth since hitting a record high above $147 in mid-July, the outlook is marred by geopolitical tensions between the US and Russia and concerns Opec may decide to cut output when it meets in Vienna in September.

Energy-starved India imports more than 70 per cent of its oil, the price of which has a heavy bearing on domestic inflation.

In July, Merrill Lynch strategist Mark Matthews said that if oil prices fell below $120, inflation eased and the US banking crisis ends, Chinese and Indian stock markets could rebound. For that to happen, it will take a few more months, D'Souza said.

Rupee extends losses on RBI governor remarks

The rupee extended losses on Tuesday after the RBI Governor said special market operations with oil companies are ceasing, sparking concern the firms will buy more dollars from the market.

At 4:15 pm the partially convertible rupee was at 42.73/74 per dollar, off an high of 42.5150 and weaker than 42.55/56 at close on Monday.

The central bank since May 30 has been providing foreign exchange to oil companies to pay for their crude imports by exchanging oil bonds held by them, which it plans to stop.

"The special market operations that we have undertaken in terms of oil bonds from IOC (Indian Oil Corp) and other oil companies, I think we have already told them that the facility is ceasing," RBI governor Yaga Venugopal Reddy told a news conference following the quarterly policy review.

Shares fell 3.9 percent on Tuesday, to its lowest close in 10 days, on concerns an unexpected aggressive monetary tightening by the central bank to quash double-digit inflation would slow economic growth.

Foreign funds have sold a net $6.6 billion worth of Indian shares so far this year, after having bought a record $17.4 billion in 2007.

RBI raised its key lending rate for the third time in two months on Tuesday, taking it to its highest in seven years to quell price pressures, dampen demand and keep inflation expectations in check.

The central bank raised its short-term lending rate, known as the repo rate by 50 basis points to 9 percent and increased the cash reserve ratio, or the amount of deposits banks have to keep with it, by 25 basis points to 9 percent