• Australia - guarantee of all bank deposits for three years and will guarantee all wholesale funding to Australian banks for five years
• Brazil - reduction in reserve requirements for smaller banks, injection of R$160 billion into the banking sector, and aiding bigger banks to buy loan books of smaller banks
• France - EUR360 billion, including EUR320 billion bank lending guarantee for bank paper issued before December 31, 2009 and lasting up to five years and EUR40 billion to buy bank shares
• Germany - EUR500, including EUR80 billion for recapitalizations and EUR400 billion for bank guarantees that will run until December 31, 2009
• Hong Kong - blanket guarantee for customer deposit accounts in all HK financial institutions until year-end 2010
• India - reduction in banks' capital reserve ratio, providing Rs250 billion to lending institutions as part of a farm-loan waiver plan, and easing of rules for some foreign borrowings
• Ireland - EUR400 billion guarantee of existing and new debt and deposits over the next two years and a EUR5.5 billion bank recapitalzation plan
• Japan - ¥2 trillion for recapitalizations and to broaden repo operations
• South Korea - US$130 billion in debt guarantees and capital injections into banks
• Spain - EUR30 billion fund to buy assets from Spanish banks to help stabilize the lending industry and unfreeze credit, guarantee issues of new bank debt until December 2009, and bank deposit guarantees up to EUR100,000
• Switzerland - SFr60 billion financial aid, primarily to UBS, for share purchases and loans, and bank deposit guarantees up to SFr100,00 until yearend 2010
• United Kingdom - £400 billion, including £37 billion to buy bank shares and £250 billion in debt guarantees for short- and medium-term borrowing by banks, and an additional £500 billion for its Asset Protection Scheme (APS), under which the government insures the bank against losses on its most toxic assets (e.g., mortgage-backed securities and property loans) in return for a small fee and an obligation by the bank to increase lending to consumers and businesses. The bank absorbs the first 10% of losses, with the government assuming responsibility for the remaining 90%.

Going forward, we expect stock prices to continue to be volatile and susceptible to headline risk. Moreover, depreciation of many foreign currencies relative to the US$ is depressing US$ stock prices. Additionally, a number of companies have cut dividends to conserve capital, and this will likely continue in the future. Combined with the grim economic outlook for many economies ranging from outright recession in developed economies to slowing growth in emerging market economies, we expect share price performance to continue to weaken.

OPPORTUNITIES

WEAKNESSES

In addition, other banks have been forced to strengthen capital through rights offerings or other forms of capital increase, such as Barclays PLC (BCS), HSBC Holdings plc (HBC) and Banco Santander Central Hispano, S.A. (STD), significantly diluting existing shareholder interests, also a negative for share prices.

Current Sells include Banco Bilbao Vizcaya Argentaria, S.A. (BBV) and Banco Santander Central Hispano, S.A. (STD).Zacks Investment Research

As in the US, non-US bank stocks continue on a downward trend this year due to the financial problems that began in the US subprime mortgage market and spread globally to engulf many major financial institutions in most countries. The median year-to-date stock price decline for non-US banks in the Zacks universe is 27.1%, compared to a loss of 21.1% for the S&P 500. This includes median price declines for non-US banks in the Zacks universe of 47.6% in Europe, 29.7% in Asia, and 14.6% in Latin America.

In response to the global financial crisis, governments have taken dramatic action to forestall the possibility of global meltdown. These rescue efforts include:

• Australia - guarantee of all bank deposits for three years and will guarantee all wholesale funding to Australian banks for five years
• Brazil - reduction in reserve requirements for smaller banks, injection of R$160 billion into the banking sector, and aiding bigger banks to buy loan books of smaller banks
• France - EUR360 billion, including EUR320 billion bank lending guarantee for bank paper issued before December 31, 2009 and lasting up to five years and EUR40 billion to buy bank shares
• Germany - EUR500, including EUR80 billion for recapitalizations and EUR400 billion for bank guarantees that will run until December 31, 2009
• Hong Kong - blanket guarantee for customer deposit accounts in all HK financial institutions until year-end 2010
• India - reduction in banks' capital reserve ratio, providing Rs250 billion to lending institutions as part of a farm-loan waiver plan, and easing of rules for some foreign borrowings
• Ireland - EUR400 billion guarantee of existing and new debt and deposits over the next two years and a EUR5.5 billion bank recapitalzation plan
• Japan - ¥2 trillion for recapitalizations and to broaden repo operations
• South Korea - US$130 billion in debt guarantees and capital injections into banks
• Spain - EUR30 billion fund to buy assets from Spanish banks to help stabilize the lending industry and unfreeze credit, guarantee issues of new bank debt until December 2009, and bank deposit guarantees up to EUR100,000
• Switzerland - SFr60 billion financial aid, primarily to UBS, for share purchases and loans, and bank deposit guarantees up to SFr100,00 until yearend 2010
• United Kingdom - £400 billion, including £37 billion to buy bank shares and £250 billion in debt guarantees for short- and medium-term borrowing by banks, and an additional £500 billion for its Asset Protection Scheme (APS), under which the government insures the bank against losses on its most toxic assets (e.g., mortgage-backed securities and property loans) in return for a small fee and an obligation by the bank to increase lending to consumers and businesses. The bank absorbs the first 10% of losses, with the government assuming responsibility for the remaining 90%.

Going forward, we expect stock prices to continue to be volatile and susceptible to headline risk. Moreover, depreciation of many foreign currencies relative to the US$ is depressing US$ stock prices. Additionally, a number of companies have cut dividends to conserve capital, and this will likely continue in the future. Combined with the grim economic outlook for many economies ranging from outright recession in developed economies to slowing growth in emerging market economies, we expect share price performance to continue to weaken.

OPPORTUNITIES

At this time, we see no near-term opportunities in this space.

WEAKNESSES

Stocks that could prove especially problematical include banks that participate in government recapitalization programs, such as The Royal Bank of Scotland plc (RBS) or Lloyds TSB Group plc (LYG). In return for the government capital, these banks must submit to other government intervention, including limits on dividend payouts and nomination of board members. This will limit their financial flexibility for a while, which could hurt stock performance.

In addition, other banks have been forced to strengthen capital through rights offerings or other forms of capital increase, such as Barclays PLC (BCS), HSBC Holdings, plc (HBC) and Banco Santander Central Hispano, S.A. (STD), significantly diluting existing shareholder interests, also a negative for share prices.

Current Sells include Banco Bilbao Vizcaya Argentaria, S.A. (BBV) and Banco Santander Central Hispano, S.A. (STD).

• Australia - guarantee of all bank deposits for three years and will guarantee all wholesale funding to Australian banks for five years
• Brazil - reduction in reserve requirements for smaller banks, injection of R$160 billion into the banking sector, and aiding bigger banks to buy loan books of smaller banks
• France - EUR360 billion, including EUR320 billion bank lending guarantee for bank paper issued before December 31, 2009 and lasting up to five years and EUR40 billion to buy bank shares
• Germany - EUR500, including EUR80 billion for recapitalizations and EUR400 billion for bank guarantees that will run until December 31, 2009
• Hong Kong - blanket guarantee for customer deposit accounts in all HK financial institutions until year-end 2010
• India - reduction in banks' capital reserve ratio, providing Rs250 billion to lending institutions as part of a farm-loan waiver plan, and easing of rules for some foreign borrowings
• Ireland - EUR400 billion guarantee of existing and new debt and deposits over the next two years and a EUR5.5 billion bank recapitalzation plan
• Japan - ¥2 trillion for recapitalizations and to broaden repo operations
• South Korea - US$130 billion in debt guarantees and capital injections into banks
• Spain - EUR30 billion fund to buy assets from Spanish banks to help stabilize the lending industry and unfreeze credit, guarantee issues of new bank debt until December 2009, and bank deposit guarantees up to EUR100,000
• Switzerland - SFr60 billion financial aid, primarily to UBS, for share purchases and loans, and bank deposit guarantees up to SFr100,00 until yearend 2010
• United Kingdom - £400 billion, including £37 billion to buy bank shares and £250 billion in debt guarantees for short- and medium-term borrowing by banks.

Going forward, we expect stock prices to continue to be volatile and susceptible to headline risk. Moreover, depreciation of many foreign currencies relative to the US$ is depressing US$ stock prices. Additionally, a number of companies have cut dividends to conserve capital, and this will likely continue in the future. Combined with the grim economic outlook for many economies ranging from outright recession in developed economies to slowing growth in emerging market economies, we expect share price performance to continue to weaken.

OPPORTUNITIES

WEAKNESSES

In addition, other banks have been forced to strengthen capital through rights offerings or other forms of capital increase, such as Barclays PLC (BCS) and Banco Santander Central Hispano, S.A. (STD), significantly diluting existing shareholder interests, also a negative for share prices.

Current Sells include Banco Bilbao Vizcaya Argentaria, S.A. (BBV) and Banco Santander Central Hispano, S.A. (STD).
"RBS" Free Stock Analysis: Buy? Sell? Hold?
"BCS" Free Stock Analysis: Buy? Sell? Hold?
"STD" Free Stock Analysis: Buy? Sell? Hold?
"LYG" Free Stock Analysis: Buy? Sell? Hold?
"BBV" Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

As in the US, non-US bank stocks continue on a downward trend this year due to the financial problems that began in the US subprime mortgage market and spread globally to engulf many major financial institutions in most countries. The median year-to-date stock price decline for non-US bank in the Zacks universe is 2.4%, compared to a loss of 3.5% for the S&P 500. This includes median price declines for non-US banks in the Zacks universe of 6.1% in Europe, 3.9% in Asia, and 0.4% in Latin America.

In response to the global financial crisis, governments have taken dramatic action to forestall the possibility of global meltdown. These rescue efforts include:

• Australia - guarantee of all bank deposits for three years and will guarantee all wholesale funding to Australian banks for five years
• Brazil - reduction in reserve requirements for smaller banks, injection of R$160 billion into the banking sector, and aiding bigger banks to buy loan books of smaller banks
• France - EUR360 billion, including EUR320 billion bank lending guarantee for bank paper issued before December 31, 2009 and lasting up to five years and EUR40 billion to buy bank shares
• Germany - EUR500, including EUR80 billion for recapitalizations and EUR400 billion for bank guarantees that will run until December 31, 2009
• Hong Kong - blanket guarantee for customer deposit accounts in all HK financial institutions until year-end 2010
• India - reduction in banks' capital reserve ratio, providing Rs250 billion to lending institutions as part of a farm-loan waiver plan, and easing of rules for some foreign borrowings
• Ireland - EUR400 billion guarantee of existing and new debt and deposits over the next two years and a EUR5.5 billion bank recapitalzation plan
• Japan - ¥2 trillion for recapitalizations and to broaden repo operations
• South Korea - US$130 billion in debt guarantees and capital injections into banks
• Spain - EUR30 billion fund to buy assets from Spanish banks to help stabilize the lending industry and unfreeze credit, guarantee issues of new bank debt until December 2009, and bank deposit guarantees up to EUR100,000
• Switzerland - SFr60 billion financial aid, primarily to UBS, for share purchases and loans, and bank deposit guarantees up to SFr100,00 until yearend 2010
• United Kingdom - £400 billion, including £37 billion to buy bank shares and £250 billion in debt guarantees for short- and medium-term borrowing by banks.

Going forward, we expect stock prices to continue to be volatile and susceptible to headline risk. Moreover, depreciation of many foreign currencies relative to the US$ is depressing US$ stock prices. Additionally, a number of companies have cut dividends to conserve capital, and this will likely continue in the future. Combined with the grim economic outlook for many economies ranging from outright recession in developed economies to slowing growth in emerging market economies, we expect share price performance to continue to weaken.

OPPORTUNITIES

At this time, we see no near-term opportunities in this space.

WEAKNESSES

Stocks that could prove especially problematical include banks that participate in government recapitalization programs, such as The Royal Bank of Scotland plc (RBS) or Lloyds TSB Group plc (LYG). In return for the government capital, these banks must submit to other government intervention, including limits on dividend payouts and nomination of board members. This will limit their financial flexibility for a while, which could hurt stock performance.

In addition, other banks have been forced to strengthen capital through rights offerings or other forms of capital increase, such as Barclays PLC (BCS) and Banco Santander Central Hispano, S.A. (STD), significantly diluting existing shareholder interests, also a negative for share prices.

Current Sells include Banco Bilbao Vizcaya Argentaria, S.A. (BBV) and Banco Santander Central Hispano, S.A. (STD).

As in the US, non-US bank stocks have been hammered this year due to the financial problems that began in the US subprime mortgage market and spread globally to engulf many major financial institutions in most countries. The median stock price decline for non-US bank in the Zacks' universe is 57.5% compared to a loss of 42.1% for the S&P 500. This includes median price declines for non-US banks in the Zacks' universe of 76.5% in Europe, 59.3% in Asia, and 47.0% in Latin America.

In response to the global financial crisis, governments have taken dramatic action to forestall the possibility of global meltdown. These rescue efforts include:

    
• Australia -- guarantee of all bank deposits for three years and will guarantee all wholesale funding to Australian banks for five years     
• Brazil -- reduction in reserve requirements for smaller banks, injection of R$160 billion into the banking sector, and aiding bigger banks to buy loan books of smaller banks     
• France -- EUR 360 billion, including EUR 320 billion bank lending guarantee for bank paper issued before December 31, 2009 and lasting up to five years and EUR 40 billion to buy bank shares     
• Germany -- EUR 500, including EUR 80 billion for recapitalizations and EUR 400 billion for bank guarantees that will run until December 31, 2009     
• Hong Kong -- blanket guarantee for customer deposit accounts in all Hong Kong financial institutions until year-end 2010     
• India -- reduction in banks' capital reserve ratio, providing Rs250 billion to lending institutions as part of a farm-loan waiver plan, and easing of rules for some foreign borrowings     
• Ireland -- EUR 400 billion guarantee of existing and new debt and deposits over the next two years     
• Japan -- ¥2 trillion for recapitalizations and to broaden repo operations     
• South Korea -- US$130 billion in debt guarantees and capital injections into banks     
• Spain -- EUR 30 billion fund to buy assets from Spanish banks to help stabilize the lending industry and unfreeze credit, guarantee issues of new bank debt until December 2009, and bank deposit guarantees up to EUR 100,000     
• Switzerland -- SFr60 billion financial aid, primarily to UBS AG (UBS), for share purchases and loans, and bank deposit guarantees up to SFr100,00 until year-end 2010     
• United Kingdom -- £400 billion, including £37 billion to buy bank shares and £250 billion in debt guarantees for short- and medium-term borrowing by banks

OPPORTUNITIES

At this time, we see no near-term opportunities in this space.

WEAKNESSES

Stocks that could prove especially problematical include banks which participate in government recapitalization programs, such as The Royal Bank of Scotland plc (RBS) or Lloyds TSB Group plc (LYG). In return for the government capital, these banks must submit to other government intervention, including limits on dividend payouts and nomination of board members. This will limit their financial flexibility for a while, which could hurt stock performance.

In addition, other banks have been forced to strengthen capital through rights offerings or other forms of capital increase, such as Barclays PLC (BCS) and Banco Santander Central Hispano, S.A. (STD), significantly diluting existing shareholder interests, also a negative for share prices.

Current Sells include Banco Bilbao Vizcaya Argentaria, S.A. (BBV) and Banco Santander Central Hispano, S.A.

Like a parent dispelling a childhood nightmare, FDR soothed the masses with the assurance that they had nothing to fear but fear itself. To this day, he is revered for turning a depression into the Great Depression. In the aftermath of the dot-com bubble, Fed Chairman Alan Greenspan came to the rescue with a brand-new bubble in real estate.

Even if there was someone out there who could pull off one more illusionary rescue, it would only delay…

Like a parent dispelling a childhood nightmare, FDR soothed the masses with the assurance that they had nothing to fear but fear itself. To this day, he is revered for turning a depression into the Great Depression. In the aftermath of the dot-com bubble, Fed Chairman Alan Greenspan came to the rescue with a brand-new bubble in real estate.

Even if there was someone out there who could pull off one more illusionary rescue, it would only delay…

More from Investor’s Daily Edge:

Equities aren’t the only markets acting strangely these days. The bond markets are acting even stranger.

For both bond and equity markets the cause of this strange behavior is the same: Piecemeal government actions in the U.S., Europe and Asia culminating in massive intervention.

The U.S. government is trying to nurse the economy back to health. And like a doctor who has…

Investors will be utterly confused today about what to fear most. First, you had the nightmare open in New York on Friday. The futures markets were limit down and closed briefly. By the time order was restored to electronic markets, the Dow opened down 6%.

The Dow rallied-if you can call it that-to close down “just” 3.6% on the day. A that point, you could safely say the market was ‘pricing in’ the fear of a global recession, and just what that would mean for corporate earnings. Not…

– Saudi Arabia, meanwhile, has announced it will pour $2.3 billion in loans to low-income borrowers.

– There are also signs of trouble in boom town Dubai. The WSJ reports that real-estate brokers there say they are seeing signs of “price weakness” there. We can only presume this is real-estate broker speak for “Nobody’s buying.”

– Over the weekend, “Dr. Doom,” aka New York University economics professor Nouriel Roubini, told The…

"Government owning a stake in any private U.S. company is objectionable to most Americans - me included," U.S. Treasury Secretary Henry Paulson said announcing his decision to effectively nationalize the nation’s banking sector. “Yet, the alternative of leaving businesses and consumers without access to financing is totally unacceptable.”

A government investment of $250 billion amounts to about 25% to 30% of the market capitalization for publicly traded banks, Rajiv Sobti, chief investment officer at Nomura Global Alpha, a unit of Nomura Asset Management U.S.A. told BusinessWeek.

The $250 billion investment will be allocated as follows:

• Citigroup Inc. (C) JPMorgan Chase & Co. (JPM) and Bank of America Corp. (BAC) each get $25 billion.
• Wells Fargo & Co. (WFC) will receive between $20 billion and $25 billion.
• Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS) each get $10 billion.
• The Bank of New York Mellon Corp. (BK) and State Street Corp. (STT) receive between $2 billion and $3 billion apiece.

The remainder, between $124 billion and $131 billion, will be dispersed among smaller banks and thrifts.

Each bank will issue preferred stock to the U.S. government that will pay special dividends at a 5% interest rate, which will increase to 9% after five years. Additionally, the government will receive warrants worth 15% of the face value of the preferred stock.

Participating banks will also have to accept limits on executive pay, the abolition of so-called golden parachutes and improper bonuses, and may be forced to reduce or eliminate dividends.

The government, so far, has insisted that the banks will not have to cut their dividends, nor will any executives be forced to resign. The chief executives of Royal Bank of Scotland Group PLC (ADR: RBS), HBOS PLC (OTC: HBOOY), and Lloyds TSB Group PLC (ADR: LYG) were all forced to resign Monday during the British government’s nationalization process.

While the original U.S. bailout plan indicated that banks would be encouraged to participate on a volunteer basis, the chief executives of the nine largest U.S. banks were summoned to Washington and convinced to take part in the recapitalization effort, as a way to avoid stigmatizing any one bank.

Had any one bank asked for help, it would have been a signal to the world that it couldn’t survive, said Daniel Clifton, an analyst for institutional broker Strategas Research Partners.

Therefore, the Treasury had little choice but to "jawbone them into taking the money in a coordinated fashion all at the same time.”

“These are healthy institutions, and they have taken this step for the good of the U.S. economy,” Paulson said of the financial firms.

Afterwards, Paulson further elaborated on the role these institutions must play in restoring liquidity to the market.

“The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it,” Paulson said.

In addition to $250 billion recapitalization effort, the U.S. Federal Reserve will start a program to become the buyer of last resort for commercial paper and the Federal Deposit Insurance Corp. (FDIC) will offer an unlimited guarantee on bank deposits in accounts that do not pay interest. The government will also expand deposit insurance to cover all small business deposits.

Over the past several months, small businesses, which typically maintain balances well above insurance limits, have been withdrawing their money in record amounts. The Fed initially tried to solve this problem by raising its deposit insurance limit from $100,000 to $250,000, but that only extended coverage to about 68% of all small business deposits, according to financial services consulting firm Oliver Wyman Group.

Abolishing deposit insurance limits for small businesses altogether would cover the remaining 32%, the New York Times reported.

“Imposing unlimited deposit insurance doesn’t fix the underlying problem, but it does reduce the threat of overnight failures,” Jaret Seiberg, a financial services policy analyst at the Stanford Group in Washington, told the NY Times. “If you reduce the threat of overnight failures, you start to encourage lending to each other overnight, which starts to restore the normal functioning of the credit markets.”

Source: Paulson Announces New Plans to Buy Equity Stakes in Banks and Revive Credit Markets

"Government owning a stake in any private U.S. company is objectionable to most Americans - me included," U.S. Treasury Secretary Henry Paulson said announcing his decision to effectively nationalize the nation’s banking sector. “Yet, the alternative of leaving businesses and consumers without access to financing is totally unacceptable.”

A government investment of $250 billion amounts to about 25% to 30% of the market capitalization for publicly traded banks, Rajiv Sobti, chief investment officer at Nomura Global Alpha, a unit of Nomura Asset Management U.S.A. told BusinessWeek.

The $250 billion investment will be allocated as follows:

• Citigroup Inc. (C) JPMorgan Chase & Co. (JPM) and Bank of America Corp. (BAC) each get $25 billion.
• Wells Fargo & Co. (WFC) will receive between $20 billion and $25 billion.
• Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS) each get $10 billion.
• The Bank of New York Mellon Corp. (BK) and State Street Corp. (STT) receive between $2 billion and $3 billion apiece.

The remainder, between $124 billion and $131 billion, will be dispersed among smaller banks and thrifts.

Each bank will issue preferred stock to the U.S. government that will pay special dividends at a 5% interest rate, which will increase to 9% after five years. Additionally, the government will receive warrants worth 15% of the face value of the preferred stock.

Participating banks will also have to accept limits on executive pay, the abolition of so-called golden parachutes and improper bonuses, and may be forced to reduce or eliminate dividends.

The government, so far, has insisted that the banks will not have to cut their dividends, nor will any executives be forced to resign. The chief executives of Royal Bank of Scotland Group PLC (ADR: RBS), HBOS PLC (OTC: HBOOY), and Lloyds TSB Group PLC (ADR: LYG) were all forced to resign Monday during the British government’s nationalization process.

While the original U.S. bailout plan indicated that banks would be encouraged to participate on a volunteer basis, the chief executives of the nine largest U.S. banks were summoned to Washington and convinced to take part in the recapitalization effort, as a way to avoid stigmatizing any one bank.

Had any one bank asked for help, it would have been a signal to the world that it couldn’t survive, said Daniel Clifton, an analyst for institutional broker Strategas Research Partners.

Therefore, the Treasury had little choice but to "jawbone them into taking the money in a coordinated fashion all at the same time.”

“These are healthy institutions, and they have taken this step for the good of the U.S. economy,” Paulson said of the financial firms.

Afterwards, Paulson further elaborated on the role these institutions must play in restoring liquidity to the market.

“The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it,” Paulson said.

In addition to $250 billion recapitalization effort, the U.S. Federal Reserve will start a program to become the buyer of last resort for commercial paper and the Federal Deposit Insurance Corp. (FDIC) will offer an unlimited guarantee on bank deposits in accounts that do not pay interest. The government will also expand deposit insurance to cover all small business deposits.

Over the past several months, small businesses, which typically maintain balances well above insurance limits, have been withdrawing their money in record amounts. The Fed initially tried to solve this problem by raising its deposit insurance limit from $100,000 to $250,000, but that only extended coverage to about 68% of all small business deposits, according to financial services consulting firm Oliver Wyman Group.

Abolishing deposit insurance limits for small businesses altogether would cover the remaining 32%, the New York Times reported.

“Imposing unlimited deposit insurance doesn’t fix the underlying problem, but it does reduce the threat of overnight failures,” Jaret Seiberg, a financial services policy analyst at the Stanford Group in Washington, told the NY Times. “If you reduce the threat of overnight failures, you start to encourage lending to each other overnight, which starts to restore the normal functioning of the credit markets.”

Source: Paulson Announces New Plans to Buy Equity Stakes in Banks and Revive Credit Markets

The medium-term outlook is sensitive to external developments and policy responses. A benign external environment, featuring even higher steel prices and FDI, could produce growth in excess of 7 percent, but inflation could prove hard to control under a peg. Under an adverse external outlook, by contrast, the peg could lead to external sustainability problems.
IMF 2006 Article IV Consultation Staff Report (February 2007)

“The growth forecast for 2008 reflects strong performance during the first half of the year, terms-of-trade gains, and indications of a bumper harvest,” the October 2008 IMF World Economic Outlook report stated. “Going forward, growth is projected to decelerate markedly, reflecting weaker export market growth, slowing real wage increases, moderating terms-of-trade gains, and higher financing costs.”

While the official exchange rate is set as Hr 4.95 – plus or minus eight percent – to the U.S. dollar, some exchange booths were offering Hr. 5.5 to Hr 6 for $1.
Kiev Post Report

The hyrvnia - Ukraine's national currency fell to an eight-year low last Wednesday, following the decision of the National Bank of Ukraine to widen the currency's trading band.

The National Bank, which has $38 billion in foreign exchange reserves, is now engaged in a delicate balancing act since while on the one hand officials are promising “strong interventions” to keep the hryvnia at roughly five to the dollar, international financing sources are drying up and Ukraine is running a growing current account deficit, which hit nearly $8 billion in July.

The strategy appears to be not to waste foreign exchange reserves, defending an arguably un-defendable exchange rate, but to conserve reserves to support banks and corporates to meet external debt service payments falling due and, also, to more generally prop up the banking sector. The problem is that the NBU can either support the currency, or support the banks and corporates but it does not really have enough foreign exchange reserves to do both at once.

Ukraine's central bank has weakened the currency's official rate against the dollar and widened its trading limits on October 7. The currency's new official rate until the end of the year was weakened to 4.95 per dollar from 4.85 and it will be allowed to rise or fall 8 percent from that level, compared with the previous 4 percent.

The hryvnia has slumped 18 percent against the dollar since Sept. 2, when President Viktor Yushchenko's party broke from its coalition with Prime Minister Yulia Timoshenko. Yushchenko dissolved the parliament yesterday, calling for new elections.


The managed currency is also being pushed down by demand for dollars from local banks and companies who need to pay down debt which they can't refinance so they have to buy dollars and pay back now. Exporters seeing this situation are also postponing selling dollars hoping for more local weakness down the road.

Nationalnyi Bank Ukrainy, which kept the hryvnia little changed against the dollar throughout 2007 and 2006, allowed it to trade more freely this year to help combat inflation, now at 26 percent. The bank strengthened the hryvnia's official rate by 4 percent to 4.854 per dollar in June, after leaving it at 5.05 per dollar since April 2005.


Declining Population The Root Of All Evil?

One of the things we should all now be learning as we look out across what is currently happening right across Eastern Europe (and I do mean right across) is that what we have is an environment where a number of long term underlying problems persist. These range from a lingering and heavy state presence in the economy, high and enduring inflation which steadily eats into the export competitiveness of manufactured goods and services, wage pressures which stem from labour supply shortages produced by out-migration and long term low fertility, and heavy balance sheet exposure due to an extensive euro- or dollarization of the banking sector (the later being the Ukraine case). The large current account deficits which follow from the above, and the consequent ongoing dependence on the arrival of substantial capital inflows can create a vulnerability to short term shocks which puts the entire macroeconomic framework at risk. The current credit crunch is, of course, almost a text book example of just such a short term shock.

This danger of a strong correction in adverse times becomes even greater (as we are now seeing) if measures are not taken (which they weren't in Ukraine's case, see this post) to drain excess liquidity from the system (by running a fiscal surplus for example), to loosen labour supply constraints by facilitating inward migration of unskilled workers, and to accelerate the pace structural reforms - and particularly those which facilitate the development of "greenfield" investment sites which help channel capital flows towards productivity-enhancing uses and in so doing raise exports. Unfortunately, at least this time round, it would seem it is a little late in the day for this kind of advice.

So to answer the question I somewhat provocatively inserted at the head of this section, Ukraine's declining population is not 100% of the problem, not by a long stretch it isn't, but it is an important component, and does form a context in which the other parameters need to be situated, and this dimension of the current crisis in Ukraine is all the more important since it is one which is normally ignored, and even more to the point, has been left unattended for so long that it has become an issue which it is very hard to address.

A Declining and Ageing Population

According to data from the State Statistics Committee , Ukraine's population fell by 290,220 in 2007. That is a rate of only just short of a million people less every 3 years. Simply there are more people dying every year than are being born, with 472,657 births being registered (up 12,000 from 460,368 for 2006) and 762,877 deaths (down slightly from 758,093 in 2006). What this means is that Ukraine's population is now falling very fast, at an annual rate of 0.675%. And remember this is the natural decline, not counting out migration. As we can see in the chart below the Ukraine population peaked in 1993, and has been in some sort of free-fall ever since.

There are a number of factors which lie behind this dramatic decline in the Ukrainian population. One of these is fertility, which is currently in the 1.1 to 1.2 Tfr range. In fact Ukraine's fertility actually dropped below the 2.1 replacement level all the way back in the 1980s, but somehow people haven't seen fixing this "bust" as being in any way particularly important.

A second factor which is also important is life expectancy, and in the Ukraine case the trend in male life expectancy has been most preoccupying, since it has been falling rather than rising in recent years. In particular male life expectancy which is currently running at around 64. Apart from stating the obvious here, we should note that the deteriorating health outlook which this low level of life expectancy reflects places considerable constraints on the ability of a society like Ukraine to increase labour force participation rates in the older age groups, and this presents a big problem since increasing later life employment participation is normally though to be one of the princple ways in which a society can compensate for a shortage of people in the younger age groups.

The third factor influencing population dynamics is obviously migration. Ukranian out-migration since the turn of the century is distinguished by two key tends: a) a reduction in intensity when compared with the very dramatic population movements which were so characteristic of the 1990s, and b) a significant change in destinations. From migrating East the Ukranians are now moving West. There is little in the way of systematic data here, but there is national level data on the numbers of Ukranians who now live and work in Portugal, Spain and Italy, together with plenty of anecdotal information about Ukranian migrant workers in Latvia, the Czech Republic, Poland and elsewhere in the EU 10.

According to information provided by Ukrainian diplomatic missions, 300,000 Ukrainian migrants may be working in Poland, 200,000 each in Italy and the Czech Republic, 150,000 in Portugal, 100,000 in Spain, 35,000 in Turkey, and another 20,000 in the US. According to official information based on the number of permits issued by the Russian Federal Migration Service, some 100,000 Ukrainian citizens currently work in Russia, although the real number of Ukrainians working there is often estimated to be more in the region of 1million.

With Fewer and Fewer People Available For Work

This out migration is very significant from the economic point of view, since the majority of those working abroad send money back on a regular basis (see chart below which shows World Bank estimates for Ukraine remittance flows) while at the same time are not present in the country to offer themselves for the work which this extra money creates. So out migration and the accompanying remittances are one thing in a high fertility, growing population like that which is to be found in Ecuador or the Philipinnes, and quite another in the long term low fertility, declining population environment of Central and Eastern Europe. Hence all that demand driven wage inflation. As we can see from the data in the chart below (which the World Bank Economists themselves recognise if surely a substantial underestimation) the flow of remittances into Ukraine has increased steadily in recent years. According to the World Bank remittances amounted to approximately 1% of Ukraine GDP in 2007, a number which seems rather small given the number of migrants involved, and one may suspect here that the data is rather underestimating the scale of the flows, but even as it is this amounts to a fiscal stimulus of 1% of GDP as a minimum.

As a result unemployment has been falling steadily over the last two years:




According to data from the Ukraine statistics office the official rate of unemplyment stood at 1.8% of the economically active population in August 2008 (down from 2.4% in January). Now these numbers are undoubtedly an underestimate of the true levels of unemplyment (the ILO compatible rate is the much higher 6.2%, but given the very special health situation in Ukraine we need to ask ourselves just how many of those who are formally included in the ILO classification are actually fit for work in a modern economy) but they do give an indication of the trend, and it is clear that some parts of the Ukraine labour market have been suffering from acute labour shortages, and hence the wage-push inflation the country has been experiencing. Wages have been rising (see chart below) at a rate which has been way above the combined inflation and productivity increase levels for many years now, and although wages did start from a very low level, and some degree of "catch up" was not only inevitable but also desireable, the complacency of the relevant authorities (both nationallly and interbationally, IMF, World Bank etc) in the face of such levels AFTER inflation really started to take off really does strike the external observer as quite extraordinary.



In many ways Ukraine could be considered to be a rather important strategic component in the whole Eastern labour supply and demographic puzzle, as we are no about to see, since many have been hoping against hope that as the recent expansion steadily drained labour supply resources across the whole region, then Ukraine would simply be able to step up to the plate and offer countries as diverse as the Baltics, Poland, Hungary, the Czech Republic and Russia the labour they needed to keep their own inflation in check. This view implied, in my opinion, that Ukraine was to become some kind of "fish farm" for the rest of Eastern Europe, and that view as we are seeing was always based on a huge misunderstanding, since a low fertility society simply cannot export labour indefinitely, and if it does try to do so, then internal wages simply explode.

In Conclusion

Of course, such demographic considerations may well seem to be rather distant from the very real and pressing drama which is breaking out in Ukraine. Obviously there are a great many lessons to be learned from the current "undoing" of the Ukraine economy. One of these is undoubtedly the desireability of moving away from dependence on one or two key commodities (steel, agriculture) whose prices are known to be very volatile and tied-in intimately with the global business cycle. Another would be the belated recognition that while FDI inflows are vital, such flows into the banking and financial sectors are not the same as inflows to fund greenfield industrial site development, and that an economy which is dependent on one or two primary commodities on the one hand, and construction associated business and financial services on the other simply is not a balanced or a stable one.

It is also clear that, whatever the well-wishing we would all like to make towards a rise in living standards for the Ukranian people, it is now abundantly clear that this cannot be achieved via a lack of vigilance towards the dangerous impact of spiraling wage-cost inflationary pressure, not can policy be adequately conducted under such circumstances by a central bank whose main priority is steering the value of a currency. Laxity and tolerance towards the inflation menace ultimately comes at a very high price, especially when it is allowed to get out of control in the way it has been in the Ukraine.

Finally, even if in fighting the short-term battle for survival which is now going to confront the Ukraine economy and its banking sector longer term demographic concerns are inevitably going to take a back seat, I think we need constantly to keep in mind that a failure to come to grips with this key ingredient in Ukraine's problem set will surely only lead to more of the same at some point in the future. So if you don't especially like suffering - and who does - then act, and act now.

India's financial system is evidently showing signs of strain as the impact of both local policy tightening and the global credit crunch steadily take hold. The rate at which Indian banks lend to each other climbed to an 18-month high of 15.125 percent on Sept. 19, following the failure of Lehman Brothers Holdings and the U.S. government takeover of American International Group. As a result the Indian finance ministry responded by allowing companies building roads, ports, utilities and other infrastructure projects to borrow more overseas - thus giving them access to cheaper funds - while the central bank announced measures to boost cash in India's financial system.

Indian banks have borrowed an average 642.8 billion rupees from the central bank in the last two weeks, more than five times the average 113 billion rupees in the previous fortnight, further indicating a shortage of funds in the banking system.

Foreign Exchange Reserves Rise Slightly

India’s foreign-exchange reserves rose by the most in five months in the week ended September 19, according to the latest data from the Reserve Bank of India. The rise has surprised many observers, but it should be borne in mind that it coincided with the rise in the dollar against a number of other currencies (and in particular the euro, which the RBI also holds in reserves) on the back of the euphoria about the possible bailout of the US financial system.

Total foreign-exchange reserves rose by $2.51 billion to $292 billion in the week ended Sept 19, while foreign-currency assets - which form the lions share of the reserves -climbed $2.5 billion to $282.8 billion during the week. As we can see from the chart (below) the value of foreign exchange reserves has stabilised since mid-August, so the rot, it would seem, has definitely stopped. I think it is significant that we saw a positive initial response across the key emerging markets to the proposed US bailout, and while we are now seeing considerable volatility as people become nervous about whether it will, finally, arrive.I think when the package is introduced the key emerging market economies will be the principal beneficiaries, as the so called "risk appetite" will bounce back, especially given that the aftermath of the package will be a lower growth period in the OECD economies as the cost of the bailout has to be assimilated.




Even given the recent decline, it is important to bear in mind that India's foreign-exchange reserves, including overseas currencies, gold and special drawing rights with the International Monetary Fund, have increased $56.1 billion in the past year.

Money Supply Continues To Grow

Meanwhile, money supply in India grew year on year by 21 % in the two weeks ended Sept. 12, same rate as in the previous fortnight, according to data from the RBI. M3 - which largely consists of currency in public circulation, bank deposits and money invested in other saving plans, stood at Rs 42,26,143 crore as on September 12.

M3 has been rising at an average rate of 21% since the current fiscal year began on April 1, and has been consistently above the central bank’s target of 16.5% to 17% for the fiscal year ending March. At the same time, total bank loans rose by Rs 32,914 crore in the two weeks ended Sept 12, the biggest fortnightly increase since March. Outstanding bank credit was up by 26.1% year on year and reached Rs 24, 91,248 crore. Food credit was up by Rs 847 crore to Rs 45,190 crore, while non-food credit increased by Rs 32,067 crore to Rs24,46,058 crore. Total bank deposits rose by 22.5%, or Rs 6, 25,282 crore, in the same period to Rs reach 34, 05,377 crore.


The Rupee Weakens Again


The rupee has declined almost 17 percent so far this year and is the second-worst performer among the ten most-active Asian currencies excluding the yen. This week it declined for the seventh consecutive week, the longest run in more than 2 1/2 years. The rupee was down 5.6 percent in September, and is thus headed for its worst month since the Asian financial crisis in 1997.

Foreign investors were net sellers of Indian stocks for a fifth straight month in September, and have offloaded $9 billion so far this year, according to data from the Securities & Exchange Board of India. They bought a record $17.2 billion in stocks last year. Indian stocks fell, with the benchmark posting its biggest weekly drop in six months, after talks on a U.S. credit market rescue plan stalled and Washington Mutual Inc. became the biggest bank failure in American history.



The Bombay Stock Exchange's Sensitive Index, or Sensex, fell 445, or 3.3 percent, to 13,102.18. The index had its biggest weekly drop since the week ended March 7. The S&P CNX Nifty Index on the National Stock Exchange slid 125.30, or 3.1 percent, to 3,985.25. The BSE 200 Index declined 3.2 percent to 1,590.58. Nifty futures for October delivery fell 3.9 percent to 3,995.

Standard & Poor's 500 Index futures slid 1.7 percent when negotiations on a $700 billion bailout plan for U.S. credit markets were thrown into doubt by a group of House Republicans who said the plan drawn up by Treasury Secretary Henry Paulson wouldn't work.

The decline in Indian stocks is more a reflection of global sentiment towards emerging market stocks and bonds than it is an indicator of any specific local issue. The MSCI Emerging Markets Index of stocks has been falling since last May - as can be seen in the chart below - and dropped 1.74% percent on Friday to 823.694, its lowest level since Sept. 15. The index is now down 13.6% so far this month, and 33.87% so far this year. But if you look carefully you can see that it peaked up again after 20th September, as speculation increased that there would be a major bailout of the US banking and insurance sector. This bounce back unwound towards the end of last week, as uncertainty grew about the arrival of the package.


A similar picture can be seen of the JPMorgan EMBI+ emerging bonds index (see below), which has been down significantly since the end of August. Since the US package seems now about to be approved for the US congress, as a result we should see sentiment improve significantly, and India may well be one of the principal beneficiaries of this change in sentiment. The coming weeks should clear all this up quite quickly.

Executive Summary


India’s latest run of strong economic growth and continuing macroeconomic stability is a tribute the important progress made in recent years in macroeconomic management techniques as well as to an earlier generation of structural reforms. India’s economy has now expanded at an average rate of about 8½ percent for four years running, on the back of rising productivity and sustained investment. Inflation after ebbing in the second half of 2007 has now returned in full force and become one of the most pressing macro problems facing the Indian economy. In fact the record capital inflows which have followed the bout of global financial turbulance and a slowing U.S. economy, while in the long run beneficial, have only served to complicate the application of sound monetary policy. The current account deficit, which had remained modest, is now – on the back of high oil prices, heavy external energy dependence and a growing fiscal deficit – in danger of becoming a matter of concern.

India Needs:

- to bring inflation back under control and to within the central bank “comfort zone”.
- to reduce the growing fiscal deficit
- to extend and substantially upgrade infrastructure

India's Strong Points:

- solid and sustained economy growth, no likelihood a a major slowdown
- significant foreign exchange reserves
- proven human capital resources
- demographic tailwinds blowing strongly in her favour, and for several decades to come


Economic Background

India’s recent macroeconomic performance has been truly impressive, the result of sound macroeconomic policies, steady reforms which have been ongoing since the start of the since 1990s, and increasingly favourable demographic tailwinds. Growth averaged about 8½ percent in the four years through 2007/08, and while it is set to drop to the 7- 8 percent range this year, India will remain one of the world’s fastest-growing economies in 2008. The poverty rate fell from 36 percent in 1993/94 to under 28 percent in 2004/05.

India’s productivity growth has also been rapid when compared with that of other countries. The IMFs September 2006 World Economic Outlook found that India’s total factor productivity growth has averaged about 3⅓ percent in recent years, which within Asia is only exceed by China. Other recent growth accounting exercises have found TFP growth for India in the range of 3.2–3.5 percent for the recent period.

It’s the demography

At the present time some some 31 % of India’s populations are under 15 years of age. Between now and 2015 that proportion isn’t expected to change too much, but after 2015, with fertility nationwide now falling rapidly, the proportion is set to decline continually, with India moving steadily nearer the proportion which is to be found in more developed economies – Ireland, for example currently has some 21% of its population under 15, while in the United Kingdom the equivalent figure is 17%.

What this means is that India post 2015 will see a steep and sustained decline in its child dependency ratio and a steady increase in the proportion of its population who are of working age. In those Asian economies (the so called “Tigers”) who have previously passed through this demographic transition such steep declines in dependency ratios have been found to boost GDP growth incrementally, and substantially. This boost is known as the “demographic dividend”. The process is not a mechanical one, of course, and to get the increment, jobs have to be created for the new entrants into the labour force, and in India’s case these jobs will be needed at something like a rate of 15 million a year. What is really different about India is that the demographers are forecasting a continuing decline in the dependency ratio for a period of 30 years or so, as India's fertility rate - that is, the average number of children a woman expects to have in her life time – (which was standing at 3.8 in 1990) falls from the present national average of 2.9 to levels which in all probability will be well below replacement level.

There is another reason why this demographic change is important and that is that we human beings exhibit variable spending and saving activity at different moments in our life cycle. Basically we tend to save most either when we have just started working and are waiting to establish a family home, or during the latter years of our working lives. Whatsmore having children makes it harder to save wherever we are in the life cycle, and thus reducing the proportion of children in a society will tend – other things being equal – to increase the level of saving.

And, not unexpectedly, India's savings rate as a percentage of GDP has been rising steadily since 2003. It now stands in the region of 33% of GDP – a figure which is comparable to the Asian super-performers, all of whom save at above 30%, with China saving at an astonishing rate of nearly 40%.

This recent savings growth has been driven in India by improvements in the government's fiscal health and a sharp rise in corporate savings, but even if these positive factors should gradually disappear, the decline in the dependency ratio should enable India to hold its savings and investment rate above the 30% mark for the next 25 years at least.

Recent Economic Indicators

The Indian economy continued to expand strongly in the first quarter of 2008, even though growth has now dropped back somewhat from the 10.1% peak reached in Q3 2006. GDP, however, still grew at a pretty solid y-o-y rate of 8.8% in Q1, and indeed output growth was unchanged from the last quarter of 2007. So while the Indian economy is slowing, it is doing so very gradually indeed.

Private consumption continued to grow rapidly in Q1 2008 (13.5%) but gross fixed capital formation dropped back (from an average of 20% y-o-y in the previous 3 quarters to 15% in Q1). Since construction activity was still running at a strong pace (12.6%, the fastest rate since Q2 2006) it would not be unrealistic to assume that spending on machinery and equipment slowed somewhat. This would also follow from the fact that manufacturing growth (5.8%) showed the slowest expansion in many quarters (well down from the 10% average over the previous 3 quarters). Infrastructure development also lagged behind in terms of electricity, gas and water supply growth, which was only up by 5.6%. Indeed utilities output has only grown by an average of around 6% over the last 8 quarters. On the other hand government spending shot up, growing at an annual rate of 22.4%. Hence here we have two of the key themes which continue to preoccupy observers of India’s economy: the slow growth of manufacturing and infrastructure, and the rapidly increasing fiscal deficit.


Both India’s exports and imports were up quite strongly in Q1 (12.7%), and this revival in exports offers some evidence that Indian exporters have now started to benefit from the weaker rupee, which has declined by some 7 percent so far this year. India's export growth accelerated again in June and overseas shipments, which account for about 15 percent of the Indian economy, were up 23.5 percent year on year (reaching a total of $14.66 billion), following a 13 percent gain in May. Imports, however, have been increasing even more quickly, and were up 26 percent (to $24.45 billion) in June, thus widening the trade deficit (as compared to June 2007) to $9.78 billion. The deficit was however down on May's whopping $10.77 billion. India's oil imports in June rose 53.4 percent to $9.03 billion as refiners paid more for crude oil purchased overseas. India relies on imports of oil for three-quarters of its energy needs. Non-oil imports gained 14 percent to $15.4 billion.India has paid an average $8 billion a month for oil imports in the year through June, compared with $5.4 billion in 2007.

India's inflation accelerated again in late July, and hit it highest level since 1995, providing additional evidence to support last week's central bank decision to raise borrowing costs for the third time in two months. Wholesale prices were up 12.01 percent in the week to July 26, after rising 11.98 percent in the previous week.



The Reserve Bank of India raised its repurchase rate by a half-percentage point to 9 percent on 29 July, giving priority to the inflation fight over India's short term growth rate. Indeed many economists consider that the bank may well increase the benchmark rate again in the next three months. The cash reserve ratio was also raised 8.75 to 9 percent and in the statement which followed the decision the bank said it still had "headroom'' to further tighten monetary policy. The bank also increased this year's inflation forecast to 7 percent from the previous range of 5 percent to 5.5 percent.



However while the inflation process in India still has some momentum, as the global economy slows – thus reducing pressure on commodity prices - and monetary tightening reins in domestic demand, India’s inflation peak can not now be far away. Despite constant ups and downs oil prices have been generally falling since hitting the record high of US$147.27 a barrel on July 11, and by August 1st they had dropped around 15 per cent in a mere three weeks. If this trend continues then India should eventually obtain some notable relief and this is why it is so important to maintain strict monetary policy and avoid second round inflation effects at this juncture.


India's industrial production provides the most evident sign of the economic slowdown, with output growing at the slowest pace in more than six years in May as continuing price rises and tightening credit lead consumers to cut back on purchases of items like cars, fridges and other manufactured goods. Industrial output was up 3.8 percent from a year earlier after gaining 6.2 percent in April. Manufacturing, which accounts for about 80 percent of India's industrial production, was up 3.9 percent. Electricity rose 2 percent, and mining grew 5.5 percent. Consumer-goods production increased 7.2 percent.




The Ratings Agencies

One notable recent development has been the decision by ratings agency Fitch to lower India's local currency credit rating. The decision by Fitch to revise India's local currency outlook to negative from stable was based on a perception by the ratings agency of a worsening fiscal position and rising inflation. The assignment of a negative outlook suggests an increase in the sovereign default rate may follow if the problem is not corrected, and this would affect the flow of funds - and hence investment - into India. The new revised local currency rating will be 'BBB-' with negative outlook as against the earlier 'BBB-' with stable outlook.

James McCormack - Head of Asia Sovereign Ratings for Fitch - is quoted as saying the "the revision to the local currency outlook is based on a considerable deterioration in the central government's fiscal position in 2008-09, combined with a notable increase in government debt issuance to finance subsidies not captured in the budget." The rating agency has revised its economic growth forecast for 2008-09 from just under 9% to 7.7%, and this seems to be not unreasonable.

Fitch did, however, continue to affirm India's long term foreign currency Issuer Default Rating (IDR) at 'BBB-' with stable outlook, its short-term foreign currency IDR at F3 and the country ceiling at 'BBB-'. The assignment of a local currency negative outlook thus means that agency has effectively put India on watch with the implication that is the underlying causes (inflation and the underlying dynamics of the fiscal deficit) are not addressed over the next 12 to 18 months, the rating could be subject to downgrade. Obviously this is a warning shot as much as anything else, and an attempt to put pressure on the Indian government.

As regards its external balance India is rather different from many other large emerging economies since while the central bank (which has a high level of independence from government) does intervene in the spot market to try to keep a lid on the rupee’s rise and to built up a “war chest” of international reserves the bank has allowed the currency to rise substantially against the US dollar (while the rupee has fallen in 2008, it appreciated by some 12% against the dollar in 2007).



Foreign Exchange Reserves

India's foreign exchange reserves fell another $504 million - to reach $306.6 billion - in the week ended July 25. Despite the fact that India’s foreign exchange reserves, have increased by $81.3 billion in the last twelve months they have in fact now been falling since May. It could be however that the increase in interest rates and the falling price of oil could now see a reversal in this trend.




The big unknown here is the future movement in the oil price. Despite the recent price easing, India still faces an import bill for crude that may reach $120 billion this fiscal year, compared with $69 billion the year before. This extra burden is about 4% of GDP.

Add the impact of the fiscal deficit to the oil bill, and it is not hard to see that the external deficit could reach 4% of GDP this fiscal year. The IMF In April were forecasting a 3.1% for 2008. Reducing this gap is now becoming a priority, especially given the comparative strictness of the ratings agencies vis-a-vis India. Any future downgrades in credit will only make funding the gap more expensive, and as we have seen attracting the foreign capital necessary to bridge the gap has been becoming harder in recent weeks.




Money Supply and Credit

Short term cash rates have been pushing the 8.5 to 9% range in India of late as liquidity has been tighter due to the significant increase in the cash reserve ratio required by the Reserve Bank of India. Banks credit remains strong and rose by 25.8% in the 12 months through July 18. Total bank deposits rose by 21%, over the same period. At the same time, money supply in India grew 20% in the two weeks ended July 18 from a year earlier, compared with 20.5% in the prior two weeks.

While much of the recent increase in lending is likely to be associated with increased credit needs on the part of the oil companies, it also seems that bank credit to other sectors has been picking up. The Reserve Bank of India is unsurpringly rather concerned about the level of credit growth, especially considering that deposit growth slowed to 21% over the same period.

The Rupee

The rupee appreciated significantly during 2007, raising concerns about the competitiveness of Indian industry. In nominal bilateral terms vis-a-vis the dollar, the appreciation has been particularly notable, reaching successive nine-year highs as it rose about 12 percent over the year. Although the increase has been lower in nominal and real effective terms—only about 7–7½ percent—the appreciation of the effective rupee has taken it out of the historical range in which it fluctuated during most of the last decade




Growth Prospects

On the growth front a large gap has now opened up between the increasingly gloomy views about India’s prospects as seen from abroad, and the relative optimism displayed by a number of internal forecasters. The Centre for Monitoring the Indian Economy (CMIE), in Mumbai, still thinks India will grow by 9.5% this fiscal year, while JPMorgan only anticipates growth somewhere in the region of 7%.



While the CMIE estimate is undoubtedly unduly high for this (calendar) year, with growth more than likely coming in in the 7.5% to 8% range, their optimism is not totally unjustified looking forward to 2009 and 2010. Trend growth in India is surely higher than many conventional analyses tend to hold, and if inflation can be gotten under control India then India may well start to hit double digit growth come 2010, and once it breaks the 10% ceiling, it may well stay above it for some considerable time. This is simply because India has a very large untapped capacity for growth, and it is not unrealistic to anticipate that this capacity can be unleased, especially if institutional reform continues, and the fiscal deficit concerns are addressed.

But things are likely to go down before they bounce back up again, since he tightening in monetary policy will surely achieve the desired effect of slowing aggregate demand and GDP growth further. Also negative global factors are likely to continue to weigh adversely on India’s growth outlook in the short term. Consumption growth has already slowed significantly. Investments growth has also begun to moderate and it is quite probable that the slowdown in the investment cycle will accentuate over the next six months.


Everything really now depends on the outlook for inflation and capital inflows. I believe that Inflation should peak in late summer at levels which are not too far above those we are currently seeing. The rate should then start moderating and we could well be back down at 7% - 8% by the end of the financial year. In part this depends on oil prices, and year on year base effects, and oil and food prices, of course, also partly depend on growth in India and the other key emerging economies. Thus we have a kind of "inbuilt stabiliser", since as the major emerging economies slow, commodity prices ease back, and as this happens the central banks can begin once more to loosen monetary policy, providing a kind of win-win feedback effect, until, of course, commodity prices bounce back again, and they need to start tightening once more.

The key point to grasp in all this is that it is consumers in the heavy energy consumption OECD economies who are going to do the heavy lifting of bearing the pain here, as resources are effectively transferred from their wallets to those of the oil producers, and it is this process, rather than what happens in the emerging economies which is likely to keep a cap on global growth in the coming years.



Outlook on Key indicators

• Following the most recent rate hike market expectations have now solidified towards further interest rate increases in the pipeline. The driving orce here will, as ever, be inflation running above the central bank's comfort zone. Here at Emerginvest we see the Reserve Bank of India being rather more prudent at coming meetings, and we feel the current rate hike cycle may possibly peak at 9.5%. Key factors here will be the behaviour of oil prices, and wages and fiscal policy in India itself with election year approaching.

• The Rupee is likely to continue to be supported by central bank tightening and declining demand for dollars from oil producers as oil prices ease. Also should the Rupee continue to head upwards and inflation start to fall, a win-win process will again be set in motion as investors see the prospect of currency related increasing returns once more opening up. In the great global search for yield there is no better winning strategy than to back a winner. At some point however macroeconomic fundamentals will undoubtedly take over, and as the economy slows and inflation moves down towards the comfort zone (around 5%) the central bank will also move into easing mode pushing the Rupee down in the process. A violent correction however is not expected.

• Obviously, with the domestic credit induced consumer boom now fading, exports are going to become more important than ever for India's headline GDP growth. India's Trade Minister Kamal Nath recently set the target of more than tripling India's share of world trade to 5 percent by the year 2020 from the current 1.5 percent. This is a worthy target, and perfectly realiseable, but it will require India to conduct a substantial infrastructural overhaul and to intruce widespread regulatory reform. In the shorter term India is targeting exports of $200 billion in the current fiscal year, up 28 percent from the $155.5 billion achieved in the previous year. This is attainable – exports were up 23.5% y-o-y in June - but with a deteriorating external environment it will be quite hard work.
  
• GDP growth is expected to moderate in 2008 compared to the levels seen in the last three years but at this point growth projections remain solid (probably 7.5 to 8% in calendar 2008). We certainly see India’s mid term sustainable growth rate as being above the consensus 7%-8% rate once inflation is firmly under control, and expect double digit annual growth rates to be hit in either late 2009 or 2010 depending on the extent to which the global slowdown in 2009 negatively affects India’s GDP growth.

• We expect India's credit ratings to remain broadly stable even as the nation weathers higher oil prices and slowing economic growth – a view which was endorsed in a statement at the start of August by Moody's Investors Service. Moody's has a Ba2 rating on India's long-term, local currency debt, leaving it two levels below investment grade, although it rates India's foreign-currency debt Baa3, the lowest investment level. The downside risk here obviously comes from fiscal laxity, but the authorities in New Delhi are undoubtedly very aware of this.
  

The Reserve Bank of India raised its repurchase rate by a half-percentage point to 9 percent on 29 July, giving priority to the inflation fight over India's short term growth rate. Indeed many economists consider that the bank may well increase the benchmark rate again in the next three months. The cash reserve ratio was also raised 8.75 to 9 percent and in the statement which followed the decision the bank said it still had "headroom'' to further tighten monetary policy.



Inflation accelerated during the week largely because of an increase in the price of pulses, fruits, spices and sugar. Manufactured price inflation was up 10.82 percent in the week ended July 19, compared with a 10.72 percent gain in the previous week.

However while the inflation process in India still has some momentum, as the global economy slows - reducing pressure on commodity prices - and monetary tightening reins in domestic demand, the peak can not now be far away. Light, sweet crude for September delivery rose 90 cents, or 0.7 percent, to $124.98 a barrel yesterday (at the 2:30 pm close of floor trading on the New York Mercantile) but prices have been falling generally since hitting the record high of US$147.27 a barrel on July 11. International oil prices have now dropped around 15 per cent over the last three weeks, and if this trend continues then India should obtain some relief.

This is why it is so important to maintain strict monetary policy and avoid second round effects.



Foreign Exchange Reserves


India's foreign exchange reserves fell another $504 million - to reach $306.6 billion - in the week ended July 25 according to data from the Reserve Bank of India weekly statistical supplement.

Gold reserves were unchanged at $9.21 billion while reserves with the International Monetary Fund fell $2 million to $515 million. The nation’s special drawing rights with the International Monetary Fund held at $11 million. Despite the fact that India’s foreign exchange reserves, have increased by $81.3 billion in the last twelve months they have in fact now been falling since May. It could be however that the increase in interest rates and the falling price of oil could now see a reversal in this trend.





Exports Up In June

Indian exporters have started to benefit from the weaker rupee, which has now declined by 7.3 percent so far this year. India's export growth accelerated in June and overseas shipments, which account for about 15 percent of the Indian economy, were up 23.5 percent year on year to reach $14.66 billion, following a 13 percent gain in May. Imports increased 26 percent to $24.45 billion, widening the trade deficit (as compared to June 2007) to $9.78 billion. The deficit was however down on May's whopping $10.77 billion. India's oil imports in June rose 53.4 percent to $9.03 billion as refiners paid more for crude oil purchased overseas. India relies on imports of oil for three-quarters of its energy needs. Non-oil imports gained 14 percent to $15.4 billion.

India has paid an average $8 billion a month for oil imports in the year through June, compared with $5.4 billion in 2007.

Even though oil prices have now moderated from their peak at around US$145, they still remain quite high by historical standards, hence the further widening in the trade deficit. Each US$10 increase in crude oil prices results in an increase of approximately US$7 billion (or 0.6% of GDP) in oil imports and the trade deficit. High non-oil import growth may also cause further widening of the current account deficit at a time when global capital inflows are slowing. Non-oil imports grew at an average of 24.9% during April-May 2008.

The big unknown here is the future movement in the oil price. Despite the recent price easing, India still faces an import bill for crude that may reach $120 billion this fiscal year, compared with $69 billion the year before. This extra burden is about 4% of GDP.

Add the impact of the fiscal deficit to the oil bill, and it is not hard to see that the external deficit could reach 4% of GDP this fiscal year. Reducing this gap is now becoming a priority, especially given the comparative strictness of the ratings agencies vis-a-vis India. Any future downgrades in credit will only make funding the gap more expensive, and as we have seen attracting the foreign capital necessary to bridge the gap has been becoming harder in recent weeks.

Obviously, with the domestic credit induced consumer boom now fading, exports are going to become more important than ever for India's headline GDP growth. India's Trade Minister Kamal Nath recently set the target of more than tripling India's share of world trade to 5 percent by the year 2020 from the current 1.5 percent. This is a worthy target, and perfectly realiseable, but it will require India to conduct a substantial infrastructural overhaul and to intruce widespread regulatory reform. In the shorter term India is targeting exports of $200 billion in the current fiscal year, up 28 percent from the $155.5 billion achieved in the previous year. This is attainable, but with a deteriorating external environment it will be hard work.


The Rupee


India's rupee was up again this week on speculation the demand for foreign currency from oil refiners would reduce following the decline in crude oil prices. The rupee touched its highest in a week on Friday and advanced 0.5 percent to 42.35 a dollar at the 5 p.m. close in Mumbai.


The rupee also strengthened on speculation gains in the benchmark stock index will encourage overseas funds to stay invested in the country. The Mumbai Stock Exchange Sensitive Index, or Sensex, climbed for a fourth week, and was up by 1.86% on Friday at the 3:00 pm close, capping its best run in three months.

Overseas investors have sold $6.9 billion more Indian equities than they bought this year through July 30, compared with $17.2 billion in net purchases in 2007. Overseas investors bought a net 5.97 billion rupees ($148 million) of Indian equities on July 31, reducing their net outflow this year from stocks to $6.62 billion, according to the India's stock market regulator.



India's stock markets were given a boost when a senior oil ministry official said the ministry had requested the finance ministry to ask the central bank to restart its foreign exchange operations with oil refiners. The central bank had said earlier in the week that it would stop a two-month old scheme which provided foreign exchange directly to oil refiners in exchange for their oil bonds. Refiners are the biggest buyers of dollars in the currency markets.


Money Supply And Liquidity Conditions

Short term cash rates held below 7 per cent in India on Friday due to lower demand for funds on the end of fortnight reporting day, since the banks had already made arrangements to fund their reserve requirements in advance. At 12:30 pm call rates were at 6.50/6.60 per cent, higher than the its previous close of 6.00/6.25 per cent, but much lower than Thursday's weighted average rate of 8.34 per cent.

Banks have to report their cash balances to the Reserve Bank of India every second Friday, this has the consequence that demand for fund tends to be lower in the second week of the fortnight as banks generally try to fund most of their requirement in the first week itself. The general impression is that call rates will now climb back towards 9 per cent at the start of a new fortnight next week.

Banks loans fell by Rs 720 crore in the two weeks ended July 18, taking outstanding advances to Rs 24,07,860 crore. Credit rose by 25.8%, or by Rs 4, 93,805 crore, in the 12 months through July 18. Total bank deposits rose by 21%, or Rs 5, 72,859 crore. At the same time, money supply in India grew 20% in the two weeks ended July 18 from a year earlier, compared with 20.5% in the prior two weeks.

So non-food credit growth stood at 25.8%Y during the fortnight ended July 18, up from the end of 2007 low of 21.9%. While much of the increase is probably due to increased credit needs on the part of the oil companies, it also seems that bank credit to other sectors has been picking up lately. The RBI is particularly concerned about the level of credit growth, considering that deposit growth had already slowed to 21% over the same period.

The RBI recently expressed its concern about this situation and stated that "It is noteworthy that the growth in credit during 2008-09 so far has taken the incremental non-food credit-deposit ratio to 82.4%, which appears high, given the prescribed CRR/SLR and banks’ preference for holding excess reserves on a day-to-day basis…In F2009 so far, however, some banks have expanded credit rapidly in relation to the system level growth, with attendant worsening of their credit-deposit ratios. These developments warrant heightened policy concerns in the interest of overall systemic stability and the quality of financial intermediation”.

And the bank warns: “If necessary, the Reserve Bank would consider undertaking supervisory review of those select banks which are over-extended in terms of their credit portfolios relative to their sources of funds”.

Fiscal Policy

The government has continued its loose fiscal policy in recent months. Apart from a higher oil subsidy, there is the off-budget burden of fertilizer and food subsidies to think about, as well as the farm loan waiver costs. The recent decision to raise wages for government employees will also add to the deficit burden. It is not unrealistic to anticipate the combined central plus state government fiscal deficit (including all off-budget spending) in the region of 7.7% in 2008 rising to 11.5% of GDP in F2009.

On the growth front a large gap has now opened up between the increasingly gloomy views of India’s prospects as seen from abroad, and the relative optimism of internal forecasters. The Centre for Monitoring the Indian Economy (CMIE), in Mumbai, still thinks India will grow by 9.5% this fiscal year, while JPMorgan, a foreign bank, anticipates growth in the region of 7%.

While the estimate is undoubtedly unduly high for this (calendar) year, with growth more than likely coming in in the 7.5% to 8% range, the optimism is not unjustified looking forward to 2009 and 2010. If inflation can be gotten under control India may start to hit double digit growth come 2010, and once it breaks the 10% ceiling, it may well stay above it for some considerable time. This is simply because India has a very large untapped capacity for growth, and it is not unrealistic to anticipate that this capacity can be unleased, especially if institutional reform continues, and the fiscal deficit concerns are addressed.

But things are likely to go down before they bounce back up again, since he tightening in monetary policy will achieve the desired effect of slowing aggregate demand and GDP growth further. Also negative global factors are likely to continue to weigh adversely on India’s growth outlook in the short term. Consumption growth has already slowed significantly. Investments growth has also begun to moderate and it is quite probable that the slowdown in the investment cycle will accentuate over the next six months.


Everything really now depends on the outlook for inflation and capital inflows. I believe that Inflation should peak in late summer at levels which are not too far above those we are currently seeing. They should then start moderating and we could well be back down at 7% - 8% by the end of the financial year. In part this depends on oil prices, and year on year base effects, and oil and food prices, of course, also partly depend on growth in India and the other key emerging economies. Thus we have a kind of "inbuilt stabiliser", since as the major emerging economies slow, commodity prices ease back, and as this happens the central banks can begin once more to loosen monetary policy, providing a kind of win-win feedback effect.

This wioll then operate until commodity prices rebound once more and the emerging central banks tighten again, etc, etc. The key point to grasp here is that it is consumers in the heavy energy consumption OECD economies who are going to do the heavy lifting of bearing the pain here, as resources are effectively transferred from their wallets to those of the oil producers, and it is this process, rather than what happens in the emerging economies which is likely to keep a cap on global growth in the coming years.

Thus the RBI is now unlikely to hike policy rates further unless oil and other commodity prices lift up again from the current levels, and if global growth slows further this is hard to see happening. The second risk to the ‘no further rate hike’ outlook is, of course, any large global financial market shock that triggers major capital outflows from emerging markets generally and from India. In such a case, the RBI would need to hike the policy rate to prevent any major depreciation in the exchange rate and consequent adverse impact on the inflation outlook. I feel however that this scenario is being rather overplayed at the present time. There will almost certainly be some kind of "emerging market correction" (in central and eastern Europe, perhaps, or possibly in China) but if this is the case it is hard to see India being in the direct line of fire, since if the money leaves India, one might well ask where it will be bound? Certainly not to Japan, where yields are still more or less on the floor, and the economy almost certainly in recession. It is also hard to see financial turmoil troubled economies in the US and Europe serving as safe havens this time round, so on balance I would put the risk of major outflows from India at a rather low level, which is not, of course, the same thing as being complacent.


More fickle, however, are the foreigners who bet large sums on Indian shares when the stockmarket was in full bloom. They are deserting the country, withdrawing $6.7 billion so far in 2008. The only consolation is that as share prices fall, so does the amount they can repatriate, relieving some of the pressure on the currency.

Reserve Bank of India governor Yaga Venugopal Reddy said yesterday that prospects of more food output this year and curbs on farm exports will boost supplies and help tame inflation, playing down chances of higher interest rates. Still, India's benchmark 10-year bond yield was unchanged at 8.23 percent, the highest in a year, after the inflation data. Inflation was mainly driven by higher costs of fuel, power and light, basic metals including steel and food grains.


India, which imports 70 percent of its oil, increased prices for gasoline by 11 percent, diesel by 9 percent and cooking gas by 17 percent after oil reached a record $135.09 a barrel in New York on May 22. India previously raised fuel prices in February, the first time since June 2006.

The changes in fuel prices announced on June 4 will be reflected in the inflation data due for release on June 20.

India's food grain production may increase to a record 227.3 million tons in the year ending June, helped by bumper rice, wheat and lentils output, the agriculture ministry said in April. It may receive an additional boost as rainfall in the four-month monsoon season that started last week is forecast to be adequate.


Foreign Exchange Reserves

India’s foreign-exchange reserves fell during the week ended May 30 by $1.6 billion to $314.6 billion, according to the Reserve Bank of India yesterday. This was the fifth week this year that this has happened, which is partly an indication that the pace of capital flows has slowed, and partly a reflection of the falling value of the rupee. Foreign-currency assets fell $1.3 billion to $304.9 billion. Gold reserves fell $225 million to $9.2 billion while its reserves with the International Monetary Fund dropped $4 million to $526 million.