Indian Economy

India's fiscal consolidation has been interrupted by a sharp increase in subsidies, populist spending ahead of elections and an increase in the public wage bill. If past reductions in government debt ratios--still well above rating peer group medians--are definitively reversed, the sovereign's local currency would likely be downgraded from the current stable outlook. Fitch Ratings (July 15, 2008)

India's credit profile has worsened in the past 12 months, but we believe the upside and downside risks to its BBB- rating are currently balanced. This assumes, however, that the reasons for credit deterioration are temporary. If we conclude that they are longer lasting, the ratings on India could be lowered again to speculative grade. Standard and Poor's (July 10, 2008)

Different global organisations. Similar gloomy outlook. And veiled threats of a downgrade. The Indian growth story is fast starting to crumble, as more and more bad news piles up. Although neither Fitch nor Standard and Poor's are ready to give any time-table for the downgrades, the threat, they say, is very real. A steady deterioration in the country's fiscal health because of a combination of adverse national and international factors is really at the core of such a decision.

Takahira Ogawa, Primary Credit Analyst at Standard and Poor's, explains: "We had originally estimated the consolidated general government deficit (including state government deficits, oil and fertiliser subsidies, and other off-balance sheet expenses) at 6.5% of GDP for 2008-09. However, with the impact of additional expenditure such as farmers' debt relief, higher oil and fertiliser prices, and the partial implementation of the Sixth Pay Commission, we now estimate the deficit could exceed 9% of GDP.''

The country's rating will depend on the Centre's ability to manage the fiscal challenges that threaten to undermine public finance gains in the short run, says Ogawa. Adds James McCormack, Chief Analyst, India Sovereign Rating, Fitch Ratings: "We expect weaker Indian economic growth, a more uncertain policy outlook and changes in global investor risk appetite to result in lower capital inflows and revenues in FY09.'' Fitch has already lowered its outlook on local currency rating to negative.  

Incidentally, any downgrade of its sovereign rating--Fitch has already changed its outlook--will mean that India will slip from the investment grade to speculative grade. However, the more important question is what such a downgrade could mean for an economy battling high inflation and interest rates, and worsening fiscal and current account deficits.

The ramifications

Mr Chidambaram told reporters that Congress - freed from the constraints of its former leftist allies - would reach across party lines to build consensus for a range of economic bills, including liberalisation of the insurance, pensions and banking sectors. "We will try to take the reform process forward," he said. "I am confident that we can secure a comfortable majority."

The victory in Tuesday's confidence vote has the potential to reinvigorate the United Progressive Alliance ruling coalition, which for the past four years has struggled to implement market-oriented reforms because of its dependence on the communists for a parliamentary majority.

The leftists finally withdrew their support for the government this month, triggering the confidence vote, after Manmohan Singh, the prime minister, pushed ahead with a civilian nuclear deal with the US that the leftists had staunchly opposed.

The turmoil in global financial markets and the rise in prices of crude oil, food and minerals have led the World Bank to revise its earlier forecasts of GDP growth. Revised forecasts show a slowdown in world GDP (in constant dollars of 2000) growth, from 3.7% in 2007 to 2.7% in 2008, in the US from 2.2% to 1.1%, in developing countries, from 7.8% to 6.5% and in India from 8.7% to 7%. Crude oil price more than doubled in a year to $140 a barrel at the end of June 2008. World prices of wheat, corn and other commodities have also risen substantially.

In India, the wholesale price index rose by 11.42% during the year ending June 14, 2008 as compared to 4.13% a year earlier. The rates of increase in the price index for food were more modest at 6.76% and 4.13% respectively. For India, which imports most of the crude oil it uses, the doubling in fifteen months of the price of the Indian basket of imported crude oil to $119.81 on June 3, 2008 is a major economic shock.

The coincidence of increases in commodity prices globally and in India does not imply that rises in global prices cause Indian price rises, as many in India seem to believe. The transmission of world prices to Indian prices is neither automatic nor full, because the extent of transmission is influenced by several crucial policy variables including the exchange rate of the rupee, import tariffs, export subsidies and prohibition of exports or imports. Also the Indian discussion seems to confuse changes in relative prices with inflation, which is a rise in absolute prices. Shocks to the supply of, and demand for, commodities could raise their relative prices. Unless they also affected aggregate supply and demand, and if they did, the policy (i.e., monetary and fiscal) failed to respond to both, the rate of inflation would be unaffected.

In the United States and in India, policymakers have attributed the recent rise in commodity prices in large part to a speculative bubble in futures markets. The US Congress is debating proposals for regulating futures markets and for curbing institutions such as pension funds from investing in commodities futures. The Indian government has already banned futures transactions in and also exports of some commodities. Most US economists do not share the law makers' perceptions. Certainly in India, but also in the US, there is no convincing empirical evidence, such as an inventory build up, of the contribution of speculative activity to commodity price increases. In fact, US inventories have fallen.

Just six months ago, India was looking good. Annual growth was 9%, corporate profits were surging 20%, the stock market had risen 50% in 2007, consumer demand was huge, local companies were making ambitious international acquisitions, and foreign investment was growing. Nothing, it seemed, could stop the forward march of this Asian nation.

But stop it has. In the past month, India has joined the list of the wounded. The country is reeling from 11.4% inflation, large government deficits, and rising interest rates. Foreign investment is fleeing, the rupee is falling, and the stock market is down over 40% from the year's highs. Most economic forecasts expect growth to slow to 7%--a big drop for a country that needs to accelerate growth, not reduce it. "India has gone from hero to zero in six months," says Andrew Holland, head of proprietary trading at Merrill Lynch India (MER) in Mumbai. Many in India worry that the country's hard-earned investment-grade rating will soon be lost and that the gilded growth story has come to an end.

Global circumstances--soaring oil prices and the subprime crisis that dried up the flow of foreign funds--are certainly to blame. But so is New Delhi. Much of the crisis India faces today could have been avoided by skillful planning. India imports 75% of its oil to meet demand, which have grown exponentially as its economy expands. The government also subsidizes 60% of the price of such fuels as diesel. In 2007, when inflation was a low 3%, economists such as Standard & Poor's Subir Gokarn urged New Delhi to start cutting subsidies. Instead, the populist ruling Congress government spent $25 billion on waiving loans made to farmers and hiking bureaucrats' salaries.

Botched Opportunities

Now those expenditures, plus an additional $25 billion on upcoming fertilizer subsidies, is adding $100 billion a year--or 10% of India's gross domestic product, or equivalent to the country's entire collection of income taxes--to the national bill. This at a time when India needs urgently to spend $500 billion on new infrastructure and more on upgrading education and health-care facilities. The government's official debt, which dropped below 6% of gross domestic product last year, will now be closer to 10% this year. "Starting last year, the government missed key opportunities" to fix the economy, says Gokarn. In fact, he adds, "there has been no significant reform done at all in the past four years"--the time the Congress coalition has been in power.

Population
India possesses the fastest growing population in the world, expanding at the rate of 16 million per year. India already is pressing China for the No. 1 spot and is due to pass its fellow Asian giant within the next generation, on its way to 1.5 million people.

This mega-nation's per-capita income is destined to eventually sextuple the per-capita income of its giant neighbor because of its much greater drive toward modern technology.

India's middle class numbers 330 million and is fast growing. Their newly earned money is spent on retail sales growth, averaging 13 percent or more for the next several years.

Infrastructure
The government's investment in the country's infrastructure is skyrocketing, rising 9.9 percent in 2007. Automotive sales are accelerating at a 17 percent growth rate; airline passenger traffic is expected to more than triple over the next five years from 14 million to about 50 million people per year.

India's government already has issued plans on spending $90 billion on industrial-related projects over the next three years.

This will include:

High-speed rail freight lines.

Power plants to supply an additional 4000 megawatts.

Three new seaports.

Six new airports.

12 new industrial clusters.

Over the next four years, by 2012, the Indian government plans on spending a total of $500 billion to build out and improve India's infrastructure.

Manufacturing
Manufacturing accounts for almost 30 percent of India's economy. India has lately become a world leader in the technology service industry. It now handles the outsourcing for hundreds of U.S.-based computer hardware and software manufacturers and telecoms.

• Natural resources
  
• Investment
  
• Corporate earnings

After a hectic day of meetings there, Kumar was back at the Kolkata airport by 8.30 pm, and soon heading home to Durgapur, in time to be with his family for a slightly late dinner at 11 pm. "Making it to Agartala in a day and back would have been unthinkable even three years back when commute time to Kolkata itself used to take anywhere between five to seven hours," he says.

That's history. The four-laned National Highway No 2 or Durgapur Expressway has cut travel time to Kolkata by almost half. Many now prefer to drive down, while others take a Volvo bus to Esplanade, Kolkata's Central Business District. "I don't remember taking a train to Kolkata in the last two years," says Anand Raj of Venky Hi-tech Ispat, which manufactures TMT bars in Durgapur's Bamunara Industrial Area.

The highway, part of the Golden Quadrilateral corridor linking the four metros, has played a key role in changing the fortunes of this steel city. The upswing in steel prices over the last three years has brought in hordes of private entrepreneurs to Durgapur. This key highway, no doubt, has played a vital role.

The success of the 5,846-km Golden Quadrilateral and the ongoing 7,300-km North-South, East-West corridors, however, belie the reality of largely-decrepit road infrastructure. For a reality check, one just has to travel to Bellary, Karnataka.

It takes around six hours to reach the iron-ore rich city, some 350 km away from Bangalore. The first 200-km stretch over National Highway No. 4--the Bangalore-Tumkur road--can be covered in two-and-a-half hours. But the next 150-odd km is a bumpy stretch--laced with speed-breakers, unending streams of ore-laden trucks and innumerable rocky un-tarred patches--that takes over three hours. In fact, industrialists like Sajjan Jindal, owner of JSW Steel's Vijayanagar unit in the city, have simply decided to give the roads a miss and have instead started taking the aerial route.

In large parts of the country, rural and feeder roads have nowhere to be seen, especially as one goes deeper into the hinterland. Less than 50% of roads are paved, says a World Bank report on India's dismal road infrastructure. Most roads do not even withstand one good monsoon.

Companies and consumers can expect another round of monetary tightening and administrative measures as headline inflation based on the wholesale price index crossed double digits to touch 11.05 per cent for the week ended June 7, the highest since May 6, 1995.

The inflation numbers spooked the stock markets, with the benchmark Sensitive Index dropping to its lowest in almost 10 months. The Sensex fell 516.70 points, or 3.4 per cent, to 14,571.29, its lowest since August 24. All but one stock in the index fell.

The 13-year high beat all analysts' -- and the government's -- expectations by almost 100 basis points and reflected the impact of the June 4 increase in auto and cooking fuels.

Petrol prices were raised by Rs 5 per litre, diesel by Rs 3 per litre and LPG by Rs 50 per cylinder after the basket of crude oil that Indian refineries buy touched $125 per barrel.

The inflation rate stood at 8.75 per cent in the previous week and 4.28 per cent in the corresponding week the previous year.

"Ninety-four per cent of the weekly jump is on account of fuel," Finance Minister P Chidambaram said in a brief statement outside his North Block office this afternoon.

"Inflation for the current week also captured rupee depreciation making imports dearer," said Dharmakirti Joshi, principal economist, Crisil.

"This is indeed a very difficult time," Chidambaram said, adding: "We will have to look at stronger measures on the demand side and the monetary side."

The government has already taken several fiscal and administrative measures like banning the export of some food items and cement, cutting import duties, banning futures trading in some items, and reducing customs and excise on petroleum products to curb the price rise.

Analysts and companies expect the inflation rate to stay above 10 per cent in the weeks ahead as the fuel price rise works its way through the system.

"The inflation rate will be around 11.45 per cent next week," said Saugata Bhattacharya, vice-president, economic research, Axis Bank, attributing the rise to an increase in private transport prices that will push up fruit and vegetable rates.

"Even by December the inflation rate will remain close to 10 per cent. It will decline only by January or February, but not below 9 per cent," he added.

"The wholesale price index does not look like coming down unless there is a very sharp correction in crude oil and commodity prices," Joshi added.

Meanwhile, with the inflation rate consistently above the Reserve Bank of India's comfort level of 5 to 5.5 per cent since February (see chart), bankers and economists expect the central bank to raise the cash reserve ratio (CRR), the proportion of deposits the central banks require banks to keep with it, 25 to 50 basis points.

WHAT
STOKED INFLATION

Weight in index

Per cent increase*
Light diesel oil
0.16     21
LPG
1.83     20
Naphtha
0.41     17
Furnace oil
0.49     15
ATF
0.17     14
Petrol
0.89     11
High speed diesel
2.02     10
Bitumen
0.15     7
* week-on-week

While most public sector banks indicated they would not revise interest rates immediately, the country's second-largest private sector bank, HDFC Bank, raised its prime lending rate 25 basis points to 15.25 per cent.

Last week, the RBI raised the repo rate 25 basis points to 8 per cent, the highest in 5½ years.

The repo rate was raised for the first time in more than a year in a bid to curb demand, which is widely seen as stoking inflation.

India Inc is worried. K V Kamath, who heads ICICI Bank, India's largest private bank and is president, Confederation of Indian Industry, said inflation was reaching the "concern zone".

"This is criminal... An interest rate rise is now imminent, which is a very worrying factor for the automobile industry. The situation is getting out of control," said Ajay Seth, chief financial officer of India's largest passenger carmaker, Maruti Suzuki.

Some corporate chiefs, however, remain upbeat. Keki Mistry, vice-chairman & managing director of HDFC, India's largest home mortgage institution, said the company would take a call on raising interest rates in a couple of weeks. But he does not see much of an impact on home loans even if the rates rise 50 basis points.

"For a Rs 15-lakh loan, the best rate to a customer, assuming the interest rate was 10.25 per cent, effectively results in an actual cost of 5.1 per cent to a borrower because of the tax concessions," he said. The average loan size for HDFC is Rs 14 lakh.

Adi Godrej, chairman of Godrej group, said: "Some inflation-sensitive sectors may be impacted but the overall fundamentals are strong. With the monsoons panning out well, growth should be strong this year."

With today's numbers, India has joined the ranks of a few other Asian economies with double-digit inflation like Vietnam (25 per cent), Indonesia (10.4 per cent). China's inflation has come down to 7.7 per cent in May but is expected to rise again with an 18 per cent increase in petrol and diesel prices Thursday.

However, these countries measure inflation in terms of their retail prices whereas headline inflation in India is based on wholesale prices. Meanwhile, the Communist Party of India (CPI), one of the Left parties that support the government, demanded Chidambaram's dismissal, saying all his measures to control inflation have been a total failure.

"We want his immediate ouster," CPI General Secretary A B Bardhan told reporters in Raipur, Chhatisgarh.

President of the opposition Bharatiya Janata Party (BJP) Rajnath Singh said, "The UPA rule will down in history only as an era of `golden failures'."

He said the BJP-led National Democratic Alliance, which was in power from 1999 to 2004, "left behind a legacy of sound macro-economic indicators and an economy of surpluses".

According to global consultancy Grant Thornton's International Business Report 2008 on emerging global markets, China, India and Russia have emerged as the top three most-favoured destinations for investment and development.

These are followed by Mexico at fourth and Brazil at fifth place. The study also revealed the presence of 22 other rapidly growing global economies, including Malaysia, Indonesia, Iran, Pakistan, Thailand and Poland, that offer immense avenues for future growth.
"Emerging markets offer great potential for growth in a global economic slowdown scenario," Grant Thornton India National Markets Leader Monish Chatrath said.
"Availability of low-cost yet highly educated labour force with strong work ethics, combined with fast industrialisation, technology deployment and a strong focus on infrastructure development is enabling these countries to close the gap with the more affluent and relatively slower-growing mature economies," Chatrath said.

"India's position in the second place comes as no surprise. The Indian economy has consistently been riding high on waves of growth since the 1990s and the current scenario has been characterised by an almost insatiable enthusiasm for technology, openness to global trade and tangible progress towards fiscal consolidation," Monish said.

The Foreign Investment Promotion Board (FIPB) also cleared Mauritius-based Indivision India Partners' proposal to invest foreign equity worth Rs 120 crore in a company engaged in merchant banking and other NBFC activities.

A proposal of Sweden's Volvo to invest Rs 123 crore for 8.1% stake in the proposed JV with Eicher Motors also received a green signal from the FIPB. However, another Volvo proposal has been referred to the Cabinet Committee on Economic Affairs (CCEA), as the investment involved is above Rs 600 crore.

Vodafone Essar also got an approval to convert operating company into an operating-cum-holding company to make downstream investment in a company engaged in telecom infrastructure business. However, the proposals of the realty firm DLF Limitless Developers and software giant Pepsi India were deferred by the FIPB.

DLF Limitless Developers had sought approval to issue shares in lieu of pre-incorporation expenses, while Pepsi India wanted the government to waive off the divestment condition which required it to offer a part of equity stake to Indian shareholders.

Industrial output growth slumps to 3% in March on a steep base of 14.4%. But with inflation soaring & the rupee sliding, there's little hope of a rate cut for India Inc

    THE sharp drop in industrial production in March to a six-year low of 3% may have triggered fears of a slowdown, but economists are still holding onto an 8%-plus growth projection for 2008-09. The optimism among policymakers and economists, however, is not shared by industry players, who believe that high interest rates and rising input costs have started impacting demand.

    High inflation, however, rules out any possibility of rate cuts to stimulate growth. Industrial production, as measured by the Index of Industrial Production (IIP), grew at a disappointing 3% in March 2008 compared to 14.4% in March 2007. As a result, industrial production growth slipped to 8.1% in 2007-08 from 11.6% in 2006-07.

    The industrial growth rate for March 2008 is the lowest since February 2002. But the government has little leverage to boost growth. "In view of high inflation as well as inflationary expectations looming over the economy due to spiralling crude and commodity prices along with a depreciating rupee, maintaining price stability will be a difficult task for the central bank. Thus, expecting any kind of rate cut is completely out of question,'' said Crisil principal economist DK Joshi.

    The industrial slowdown is largely because of the sharp drop in manufacturing, which has a high weightage in IIP. Manufacturing grew 2.9% in March 2008 against 16% in March 2007. Even electricity (3.7%) and mining (3.8%) grew below their trend rates.

    There is a silver lining, though, since part of the drop appears to be due to the high base effect--industrial growth in March 2007, the base for calculating growth in March 2008, was unusually high. "There is certainly a base effect, and average industrial growth has slowed down in the current year from about 10-10.5% in the previous year. If you take the month-on-month numbers and look at March over February, you will find a 23-point increase in the general index, which will translate to a growth of nearly 8.5%. Basically, in March 2007, growth had been 37 points over a base of 250, so that was a huge increase. We are really seeing the base effect and there is no slowing down if you look at it on a month-on-month basis," Central Statistical Organisation head Pranab Sen said.

    The higher sequential growth (March over February), which had turned negative in February 2008, underscores the point. IIP went up by 23 basis points in March 2008 over February 2008, after registering a fall of 8 basis points in February over January.

    But there are others who are not buying the high base effect explanation. Industrial growth is slowing down, they argue, thanks to higher interest rates and rising cost of inputs, which are hitting company margins and their ability to invest. Capital goods sector shows signs of fatigue

    Deutsche Bank Asia Pacific head Sanjeev Sanyal said, "There is no doubt that higher base effect is the main reason, However, in view of rising cost of production and slackening consumer demand, one cannot deny that companies are cutting production as well as investments. It's not only a languished consumer durables sector but also the manufacturing sector, which grew at a mere 2.9% in March, that has dragged the whole index down. It is a cause for concern."

    The growth in capital goods sector is showing signs of fatigue. It has slipped to 8.6% from 18.1% in the corresponding period last year. The consumer durables sector continues to worry. It turned in a negative growth of 2.1% in March 2008 as compared to a 3.8% rise in the same month last year. In fact, between April 2007 and March 2008, the average growth in the sector was (-)1%. This is largely due to the decline in two-wheeler sales.

    The de-growth that the motorcycle industry is witnessing is largely due to lack of enough retail finance options for motorcycle buyers. Even the excise cut has not helped. "Unless the retail finance situation improves, the motorcycle industry will see little impact of the excise duty cut," said Hero Honda managing director Pawan Kant Munjal.

    The lower March numbers have come in the backdrop of RBI's annual monetary policy, where it has forecast higher industrial growth in the coming months and maintained the GDP growth target at 8-8.5%, much higher than experts' forecast of 7.5-8%. With crude prices touching new highs and inflation continuing to rise--it touched a three-anda-year high of 7.6% for the week ended April 26--the central bank may not be in a hurry to cut rates.

Software companies, especially the mid- and small-sized ones, can now breathe easier with the Government initiating a move to extend the Software Technology Parks of India (STPI) scheme by one more year.

The proposal to extend the STPI scheme by a year till March 2010, may allow companies to continue with present tax incidence for one more year. The benefit is more pronounced for mid-tier and smaller IT services, given that they could not have easily used the option of moving to SEZs to keep their tax rates under check.
Tax benefits

Companies such as MindTree, Zylog Systems and Hexaware currently have a tax incidence of between 10 per cent and 12 per cent, around the MAT rate. They were all staring at a jump in incidence to 20-22 per cent, once the tax benefits under Section 10A (relating to STPI) were removed.

In light of uncertain IT spends of global clients and pricing pressures, which by themselves present challenges, a higher tax incidence would have further cut into these companies' profitability. Top-tier IT services companies such as Infosys, TCS and Satyam, which pay between 12 and 15 per cent of profits to the taxman, would also stand to benefit from this proposal. The extended time window may help them plan their migration to SEZs better.
Mixed impact

The Government's proposal to introduce a 5 per cent export duty on primary steel and HR (hot rolled) coils may provide the much-needed relief on raw material costs to the domestic steel pipe makers. But, the proposed export tax could adversely impact companies with a large export presence. Companies such as PSL and Maharashtra Seamless, which sell mainly in the domestic markets, would benefit significantly from the move, as they may get relief from upward-bound steel prices.

However, the move to impose a 10 per cent export duty on steel pipes is adverse for companies like Welspun Gujarat Stahl Rohren, with a high reliance on exports, as it may dent realisations. The company's ability to pass on the export duty through price hikes is also uncertain in a competitive scenario. The changes would come into effect from the day the Finance Bill is passed by Parliament.

The question is no longer about whether the US financial woes will impact Indian companies. The anxiety is to know the extent to which our economy is vulnerable when the US sneezes.

But wait. Are we talking about a `fear' of US recession? We were, but now the fears have been `borne out,' says Dr Shanto Ghosh, Principal Economist, Deloitte Haskins & Sells, Bangalore.

"The International Monetary Fund (IMF) recently released its World Economic Outlook, which is widely regarded as the most authoritative report on the world economy," he adds, during a recent e-mail interaction with Business Line.

"The Report states: `The financial market crisis that erupted in August 2007 [in the US] has developed into the largest financial shock since the Great Depression, inflicting heavy damage on markets and institutions at the core of the financial system.'"

Given that the US contributes almost one-fourth of the world's GDP, it would be naïve to assume that this slowdown will simply peter out without creating a ripple, opines Dr Ghosh.

So where does this leave us? "A bit on the back foot," he fears. "We should prepare ourselves for lower growth rates, and slowdown in the services sector growth, over the next few years. There is likely to be pressure on the rupee to appreciate further which would further adversely impact the export-oriented sectors."

A globalised India will have to gear up to face the turmoil expected to rock the financial world and those days are approaching with great force, observes Dr Ghosh.

Excerpts from the interview:

What are the global forecasts that are of concern?

The World Economic Outlook predicts that global growth would slow to just 3.7 per cent this year -- the slowest in five years -- and forecasts US growth to remain very sluggish (less than 1 per cent) for the next two years.

The US lost jobs for a third consecutive month in March and the unemployment rate rose to the highest level since September 2005. The chairman of the Federal Reserve Bank, Ben Bernanke, reported to the US Congress on April 2: "It now appears likely that real gross domestic product will not grow much, if at all, over the first half of 2008 and could even contract slightly."

Consumer spending has considerably slowed down and all polls indicate that a large share of the American population holds bleak prospects for the US economy in the immediate future. Even though interdependencies between the US economy and emerging economies like India and China have reduced considerably over the last two decades, it would be simplistic to imagine that this recession will have no impact on the Indian economy (as some people have suggested).

Can you explain the linkages to our financial markets?

The first of the two linkages is the impact of the US recession on our financial markets. The sub-prime crisis has revealed the lack of soundness in the US financial market.

As economist Paul Krugman puts it: "US financial markets, it turns out, were characterised less by sophistication than by sophistry, which my dictionary defines as `a deliberately invalid argument displaying ingenuity in reasoning in the hope of deceiving someone.' E.g., Repackaging dubious loans into collateralised debt obligations creates a lot of perfectly safe, AAA assets that will never go bad."

Analysis of banking system data shows that the US financial system, and that of a large part of the world, is lethally hurt. US banks have no more money; it is as simple and dramatic as that.

Some economists have predicted that the contagion will enter a second phase of development, generating a new series of bank failures by August 2008 entailing a dislocation of the global financial system in the latter half of this year.

In what ways will such a grim scenario affect the capital flows?

We should fully expect major capital outflows from the US and investors will look to invest in other markets. This is true not only for money sourced from the US but also the glut in funds that other country governments have hoarded in US dollar-denominated financial assets.

India will be a destination for these funds and the inflow of dollars will again put pressure on the rupee.

Exporters will be hurt and this is also true for real exports to the US with whom India enjoys a trade surplus. The RBI may want to sterilise the inflow of funds but this is likely to create an inflationary pressure within the economy. The bottom line -- our growth rate is likely to fall by at least three percentage points!

And the second linkage?

The second, and a more direct, linkage is with respect to the services sector. Corporate profit outlook in the US is bleak. In the face of a recession, we should expect companies to announce postponement in their capital expenditures as well as information technology budgets.

The fact that the political climate in the US is currently biased against the outsourcing of jobs from the US will have a direct bearing on the amount of dollars that are likely to flow into India as payment for the outsourced jobs. This is again a negative stimulus for the service sector which has been the engine of growth for India over the past few years.

Aren't some people arguing that the pressure to retain margins will actually result in a higher amount of outsourcing from the US to countries such as India?

There is a subtle fallacy in that argument. A recession is characterised by higher levels of unemployment. Moreover, it is a politically sensitive issue.

How likely is it that, while joblessness and job cuts attract media attention, a US company will announce further job cuts and start outsourcing jobs outside the country? In my humble opinion, such speculations are nothing but wishful thinking.

The assets of Asia's third-biggest economy stood at $302 billion, with reserve assets of $247 billion and direct investments of $35 billion accounting for the bulk, the RBI said in a report on its Web site.

Liabilities stood at $371 billion at end-September, with portfolio investments and direct investments amounting to $202 billion, over 54 percent of total liabilities.

The assets are the country's financial claims on non-residents, the RBI said, and the liabilities are its financial liabilities to non-residents.

The Board of Approval (BoA), chaired by the Commerce Secretary, Mr Gopal K. Pillai, took up nine proposals, of which five were granted formal approvals and one in-principle. Excluding the six approvals granted today, the board has granted formal approvals to 449 SEZs, of which 206 have been notified.

Of the five formal approvals granted today, four are for setting up IT/ITES zones by Brigade Enterprises in Karnataka, Wellgrow Buildcon and Sunwise Properties in Haryana and Smart City (Kochi) Infrastructure in Kerala.

The in-principle approval granted to Smart City (Kochi) Infrastructure was converted to formal nod today.

Inflation surged by 0.81% over the previous week, as essential items like fruits, vegetables and pulses, as well as some manufactured items like imported oil, mustard oil and steel, became dearer. Inflation had been at 6.51% during the corresponding week in the year-ago period. The government, which is in a bind over rising prices, is working on a warfooting to contain the price line. Apart from the cut in customs duties on crude and refined edible oils (to 20% and 27.5% respectively) effected today, and the existing ban on export of edible oil, the government is also contemplating an export duty on steel, to increase domestic supplies.

Experts say that there is an urgent need to achieve self-sufficiency in products like food and cooking oil in order to bridge the demand-supply mismatch and contain inflation. Global prices of foodgrains like rice and wheat are at record levels and even resorting to imports could put pressure on the price lines.

Beefing up supplies could be a difficult task in the short term and the government will have to fall back on fiscal measures to discourage exports while making imports of essential goods cheaper. Says HDFC bank chief economist Abheek Barua: ``Higher food and oil prices are playing a crucial role in pushing inflation up. There is urgent need to increase the food supply. However, in the short term, as raising productivity is a difficult task, the government may resort to measures such as banning exports of some commodities, and cut the import duty.'`

The numbers came just a day after the prime minister's economic advisory council chairman, Mr C Rangarajan, described the inflation rate as a little above comfort level, and said the council does not favour an interest rate cut policy.
Experts feel that as inflation has breached the RBI's comfort level by a wide margin, it would be more difficult for the central bank to reduce interest rates to bolster the slowing economic growth.

`` The whopping rise in the inflation rate, despite the high base effect, would not allow RBI to go for a rate cut in the near future as it is way above the central bank's tolerance level of 5%,'' Crisil principal economist D K Joshi said.
During the week under review, prices rose across all categories. The index of primary articles went up by 0.3%. The prices of arhar, gram and moong went up by 3%. At the same time, fruits, vegetables, maize, condiments and spices were expensive by 1%.

The index of manufactured products too rose by 0.2%. Among manufactured products, prices of imported edible oil went up by 4%, while that of groundnut oil went up by 1%. Coconut and mustard oils were dearer by 3%.

The index of fuel, power and lubricants too went up by 0.1%, as prices of furnace oil rose by 2%. Basic metal, alloys and metal products rose 20%. Prices of blooms and billets and slabs went up by a steep 30%, wire of all kinds by 25%, steel and tensile plates by 20%, and bars and roods by 3%.