The week opened on a strong note with a broad based rally on Monday as the markets brushed aside worries about terrorism and record crude prices. Expectations about robust corporate results and steady FII inflows helped the Sensex to close above 7300 for the first time ever.

Hopes about the continuation of strong corporate performance were somewhat rattled when Infosys kicked off the earnings season on Tuesday with quarterly numbers which failed to excite the markets. Though the indices tried to take it in their stride in the morning, they saw a sharp decline later in the day.

On Wednesday and Thursday markets saw the volatility continuing despite good numbers from ACC and HDFC Bank. Weakness in technology and oil stocks held the markets under pressure.

Market worries about the subsidy sharing by listed oil companies were somewhat allayed as the broad contours of the new sharing formula proposed by the government came out. Markets welcomed the formula with a strong rally in the closing hours on Friday. Rumours of some major announcement from Reliance saw the stock surging ahead and leading the rally which was also supported by a recovery in technology stocks.

Mid-caps escaped much of the volatility in frontline stocks, except for Tuesday when the index dropped sharply in the afternoon after holding higher levels in the morning. The mid-cap index managed to close with gains on all days except Thursday. The index scaled new lifetime highs on all days and closed the week at yet another lifetime high.

Domestic economic and regulatory action

• After causing some concerns during the months of March and April, industrial output for the month of June rose much higher than the same month of previous year. The Index of Industrial Production surged 10.8 per cent during May '05 as compared to a growth of 6.8 per cent in May '04.

  While manufacturing sector recorded a growth of 11.5 per cent as compared to 7.5 per cent during the previous year, electricity generation was higher by 10.6 per cent as compared to 3.1 per cent. Mining was the only laggard, reporting a growth of 3.7 per cent as compared to 5.3 per cent.

  The 11.5 per cent growth rate by the manufacturing sector is the best in recent memory. There were many sceptics who argued that India cannot sustain a manufacturing revival without much higher FDI and liberal labour laws, especially in sectors like textiles which face considerable competition from China.

  Despite all these drawbacks, the textile sector output has increased by over 35 per cent for the month. This could well be the early signs of the country gaining ground in the post-quota textile regime after the uncertainties of the first few months of the new regime.

  There is evidence in the monthly output data that the investment cycle is maintaining an uptrend, with the capital goods segment growing by over 19 per cent. Consumer demand growth is also showing no sign of deceleration, with consumer goods output recording a growth of over 19 per cent. Both consumer durables and non-durables recorded almost identical growth rates of around 19 per cent each.

  The strength of investment and consumer demand is further evidenced by the strong growth in imports for the month of May. Non-oil imports for the month surged over 43 per cent as compared to last year. The multi-fold jump in cash on corporate balance sheets would also help in sustaining the investment momentum.

  The excellent growth in electricity generation may, sadly, end up as a one month phenomenon. It would be a miracle if this growth continues into June, when most coal-based thermal power plants reduced output because of fuel shortages. However, the situation has reportedly improved in July.

  Decline in mining was more or less expected as metal prices have come down, which would have affected the offtake of ores and minerals to some extent. The PSU coal monopoly was finding it difficult to mine enough coal and worse still, to move mined coal from the pit head.

  Is the growth sustainable? Only 2 factors can affect the growth momentum as of now - monsoons and global economic growth.

  After giving some jitters in June, monsoon has picked up and has covered the entire country. Unless there is a major decline in monsoon activity over the next few weeks, overall rainfall for the season would be close to normal. Better still, except for the floods in Gujarat the rains are yet to cause any serious damage.

  Global economic growth could face some challenges in the coming quarters, with energy prices going through the roof. US economic growth would depend on the sustenance of domestic consumption demand and construction activity. The big question is can Europe put up a better show after years of slow growth, if growth in the US economy starts showing signs of slack?

• If the first quarter data is anything to go by, the implementation of VAT is progressing well and tax revenues have shown a healthy rise in most of the states which shifted to the new tax regime. Though three months is too short a period to arrive at a judgement on such a path-breaking initiative, it can be safely said that most of the earlier worries are unfounded.

  Though there were disruptions during the initial months, with traders in many states going on strike, a majority of the trading community has now accepted the new system. Many companies had reported a fall in sales immediately before and after the launch of the new VAT regime. After three months, no major corporate is blaming VAT for weak revenue growth.

  The dissenting states can now hardly put forward any justification for staying out of the VAT system. These states are ruled by the principal opposition party, who in a shameless display of political opportunism, had disowned what they themselves had proposed during their term at the centre. Once implemented nationwide, the unified tax structure would go a long way in integrating the regional markets within the country.

• Inflation for the week ended July 2002 declined marginally to 4.09 per cent from 4.14 per cent reported for the week before. The decline is surprising, as the fuel price hike during the second half of June seems to have hardly had any effect on prices. The decline was attributed to a fall in prices of food articles.

Industry update

• The domestic airline industry is expected to grow by 25 per cent during the current financial year. The industry had posted similar growth rates during the previous year as well and is the fastest growing air travel market in the world among major countries. Analysts expect the growth momentum to continue for the next several years helped by the entry of new players and declining fares.

  Jet Airways has managed to more or less hold on to its market share during the first quarter of the current fiscal even on the face of low-cost onslaught. Its market share for the first quarter stood at 41 per cent followed by state-owned Indian Airlines at 34 per cent. Air Sahara saw its market share decline by more than 2 per cent.

  However, the growth in market share of low cost airlines will definitely threaten legacy carriers like Jet. Low cost carriers have doubled their market share to over 12 per cent for the first quarter as compared to the same period of last year. With just three low-cost operators in business, two of them new entrants during the quarter, their rapid growth is bound to cause serious problems for the established airlines.

  Analysts expect low cost carriers to account for at least 25 per cent of the market by the year 2010 on a passenger base of 50 million. This seems to be very conservative, considering the fact that they would end up with at least 15 per cent market share by the end of this year.

  With at least four more new low-cost carriers expected to start operations during the next two years and the large expansion plans of the existing three operators, low-cost carriers would account for the bulk of the domestic fleet additions over the next several years. There is no reason why their share would be limited to 25 per cent, unless there is a severe downturn in the economy in the medium term and some of these new carriers go out of business.

• Passenger car sales during the first quarter of current year slipped marginally as compared to the same period in the previous year. Most manufacturers see this as a temporary decline and expect volumes to pick up during the rest of the year.

  Though there were external factors like the VAT implementation, introduction of new emission norms, higher road taxes in some states etc, it is clear that car companies cannot continue to rely mostly on urban centres to bring in volume growth. An analysis of segment wise sales shows that, the decrease in volumes was limited to the entry level models. This is a clear indication that most of the potential first-time buyers have already purchased cars and a large proportion of additional sales is coming from upgrades.

  To push for volume growth from rural markets, auto companies would have to come up with appropriate models and innovative marketing strategies. Though some of the companies have plans to address this increasingly important segment, the industry as a whole can do much better than what they are currently doing.

  Volume growth in urban markets may face a speed breaker if interest rates are to rise further. Many banks have raised the rate on auto loans recently and further increases in future may be expected as overall credit offtake is very robust. Going by the discount offers and other promotion schemes offered by major auto companies, margins could be under pressure in coming quarters even if volumes show a modest increase.

• Over the last couple of quarters, banks are facing a strange problem. The rise in deposits cannot match the increase in advances, even in absolute terms. The incremental credit to deposit ratio for most private banks and major PSU banks is above one at present as credit demand from industry is high. The expanding retail credit portfolio of most banks is adding to the pressure on funds available for lending.

  As of now, most banks are selling off part of their hoard of government securities to satisfy the credit growth. However, this cannot go on for long and the banks will have to find some way to increase the deposit growth. The fiscal disincentives to bank deposits and the lower rate of return as compared to other savings options are not helping matters either.

  To sustain the investment revival in the economy, it is vitally important that the momentum in credit growth is maintained. Unless ways are found to attract more deposits into banks, the robust growth in credit demand would invariably lead to upward pressure on interest rates which would in turn affect fresh investments.

US markets, economy and oil

• US markets closed with gains for the third week in a row as a set of positive economic data and good corporate numbers kept the optimism alive. The decline in crude prices added to the sentiment. The S&P 500 index managed to close the week on a four-year high while the technology heavy NASDAQ closed at its highest for a year.

  Most of the economic data released during the week turned out to be positive. While trade deficit for the month of May declined, US domestic inflation continues to remain subdued despite high fuel prices.

  US industrial production for the month of June recorded its highest jump for the last one year, much higher than market expectations. The manufacturing recovery was supported by a surge in output of automobiles and power generation. Retail sales for the month of June were also higher than expected.

• After topping record highs during the previous week, crude oil futures declined during the week as tropical storms in the Gulf of Mexico did not cause much damage to the oil production facilities. Opening the week around $60 to a barrel, crude lost over 3 per cent to settle at $58.09 to a barrel on the NYMEX.

  The International Energy Agency has come out with its first forecast of crude oil demand for 2006. The agency expects demand to grow by 2.1 per cent, higher than the 1.9 per cent expected during the current year. However, the agency has reduced its demand projection for the rest of the current year by 400,000 barrels per day.

  The IEA does not expect high oil prices to have much of an impact on demand for next year. It believes that the upward pressure on prices is somewhat contained for the rest of the year as inventories across the globe have gone up in anticipation of higher demand in the second half. Also, production from new oil fields are expected to come into the market this year as well as next year as producers are pumping oil at their peak capacity to benefit from higher crude prices.

  An interesting study by some influential oil analysts in the US argues that between 20 to 25 per cent of the price of crude oil is because of financial investors and speculators in the crude futures market. Investments by hedge funds and speculators in crude futures have more than doubled over the last few years and have had a major impact on the huge rally seen over the last year or so. The impact of this massive fund flow into the futures market is also evident in the high volatility of crude prices seen in recent months.
  

*Disclaimer: The author doesn't have any position in the stocks specifically mentioned above at the time of writing this article. This analysis/report is only for the purpose of information and is not an investment advice. Readers are advised to consult a certified financial advisor before taking any investment decisions. While efforts have been made to ensure the accuracy of the information provided in the content the author or publisher shall not be held responsible for any loss caused to any person whatsoever.

Other articles by Rex Mathew

List of general reports on markets

List of general reports on finance