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Deflation stalking markets

Deflation is stalking the markets, stoked by the news that the US consumer prices and producer prices index dropped. Is this the dreaded arrival of Japanese style deflation, asks Dr Dasgupta.

india Updated: Jun 04, 2003 15:19 IST

The India Babble
The markets showed a steady rise all through the week and ended up almost 100 points upwards. This was backed by a set of reasonably good figures.

There was a reported small drop in inflation to 6.14%, giving rise to a positive basis for optimistic sentiment across the board. Industrial output for the year ending March 2003 showed that it had grown by a robust 5.8% and 6% in March 2003.

We frequently ignore this good performance by India, but comparatively speaking, the latest monthly figures from Japan showed an industrial production increase of 3.8%, UK showed a negative -0.8%, USA showed a anaemic +0.4% while the Euro area had a +1.8% growth rate. Pretty good going, I would say.

The Indian industrial recovery is not patchy but across all sectors. Business confidence took a dip on the ET-NCAER business confidence index dropping about 3 points in April, but I expect this to be the Iraq War fallout and should not materially impact the growing recovery. The rupee is steadily appreciating due to the US dollar weakness, as well as significant inflows from the NRI’s and foreign portfolio investments.

An interesting report crossed my desk about the situation with respect to ports in the Arabian Sea. The premier port seems to be Dubai, with Mumbai and Colombo following. The Indian efforts to develop the Chah Bahar port in Iran is a good step, which should increase our trade efforts into the central Asian republics through Iran and Afghanistan.

Minister for Communication and IT, Arun Shourie moaned about the problem with BSNL and MTNL tariff roll-backs. When will the politicians realize that tariffs have to be rationalised? Not soon, I guess. Due to funding constraints, the rural telephony and network upgrade infrastructures will be affected seriously. Disinvestment is still being politically opposed, when will these fellows understand that the government has no business to be in business? The VAT issue has been shelved again. This is a contentious issue and there are good as well as bad points to this situation.

The good points: The country will gain a standardized tax system instead of the rat’s nest of sales tax, octroi tax, local tax, state tax, you-name-it tax. Statistics will be improved and to a large extent, tax evasion can be removed as well. On the other hand, trying to coordinate this massive exercise across all the states is a logistical nightmare and requires local state legislation to implement.

Given some of the state government’s lethargy and looming local elections, they are distracted and rather unable or unwilling to understand the sheer impact of this proposal on their state’s finances. Nobody ever accused our states of being financially smart!

Outsourcing is still in the news, with Convergys, Intuit, JP Morgan and America Online announcing take up of outsourcing contracts in India. Some good news from the trade front with the ASEAN countries and India deciding to speed up the import tariff reduction process, even before the full free trade area agreement comes into the picture. This will be a good step. Given
the European intransigence over the Doha round, I have to say that regional free trade agreements are the way forward. What I do not understand is why the grand poo bah’s at the Ministry of Industry and Trade are not working on linking other areas such as Latin America, Japan and even the USA/EU?

Petrol prices dropping in India? Not once but the third time in as many weeks? Goodness me, what is wrong with the country? This deserves an "attaboy" to the boys in the Petroleum Ministry, indeed.

The Babble in the Ivory Towers
Last week, we looked at how countries manage their macro-economic financial policies. This week, we look at the ongoing European process towards the creation of a single retail banking market.
In a recent discussion paper by Harald Sander of the University of Applied Sciences in Cologne, Germany and Stefanie Kleimeier of the Universiteit Maastricht, The Netherlands, they analyse the current state of retail banking consolidation across Europe. Wholesale financial markets are
getting considerably more integrated rather than the retail financial market, perhaps because the transactions involved in wholesale markets are considerably lesser in number and in a much bigger volume.

The authors find that the Euro is already making a seriously positive impact on the retail market integration, but issues like a lack of international arbitrage, a limited pass-through of interest rate changes onto lending rates, and a limited national and international competitive retail banking environment, are still holding back retail integration. This is important
for the variety of banking sectors around the globe, that are expanding on the wings of political and trade integration.

ASEAN, MERCOSUR and NAFTA spring to mind, where the domestic banks are slowly moving into other nations. Nationalism is a difficult barrier to cross indeed. Are you hearing this, SAFTA (South Asian Free Trade Area)?. Domestic banking sectors have to be liberalised and set free within a strong regulatory framework, before they can even think about crossing boundaries. If the domestic sector is not strong, either the banks are subsumed by external competition or are unable to take advantage of the opening of the other markets. Either way, they loose.

The World Babble
The US markets were quiet all week, taking a breath or rather shocked at the terrorist attacks in Saudi Arabia, as well as the plunging dollar. The DOW ended up a per cent over the week, while the S&P500 and the NASDAQ ended up nearer to 1.5 per cent over the week.

Deflation is stalking the markets, stoked by the news that the US consumer prices and producer prices index dropped. Is this the dreaded arrival of Japanese style deflation? And will the plunging dollar help hold back the deflationary tide? European markets showed a bit of a rally for the first two days, but started slumping from Wednesday onwards, due to the fears about the exporters getting hit by the strong Euro.

The UK market broke through the 4000 level and closed the week at 4049, the best level achieved since last December. Japan dropped about a per cent, on worries over the strong yen hitting exporters.

But the big action was in the forex markets, with trading floors abuzz with the rumours and rather sharp movements. European markets were heading down as the investors took fright at the strong Euro making life difficult for the European investors. The European auto industry got a hammering, on the back of a downgrade by Goldman Sachs. The situation is getting so bad, that
the prices of auto’s in the UK are no longer significantly different from the continent, thereby knocking a hole in the prospects of the British auto importers.

This weakening of the US dollar is benefiting the US manufacturers with almost all auto firms showing improvements in their share prices. On an overall basis, HSBC estimates that a 10% fall in the USD-EUR rate hits European corporate earnings by 3.5 per cent while increasing the US corporate earnings by 1.5 per cent. Productivity differences? Maybe!

The major European economies haven’t grown in the first quarter and if the Euro keeps on strengthening, then I would expect the entire year to be a washout and perhaps even head into negative territory. Let us not forget that the USA, unlike Europe, has a far smaller international trade component to its economy, hence the US dollar fall will hurt the Americans far less than the Euro rise will do to the export sector strong European Economy.

The European Central Bank has managed to confuse the market completely with its vague and contradictory pronouncements and the simple fact, that a rate cut is required NOW, is being missed at the rarefied ECB tower in Frankfurt.

The G7 finance ministers are meeting this weekend and I hope we have good news to report on Monday. The Bank of Japan has been intervening steadily in the market, thereby stopping the appreciation of the yen, but it is looking like a one way bet to me. Deflation fears hit the US bond market with a whammy, with the longer dated bonds taking a particularly strong hit.

Oil prices moved up after digesting the Saudi terrorist attacks, the news that Saudi Arabia is cutting production, the news that the stocks held by the developed nations were much lower, Iraqi oil production uncertainty and finally, the domestic unrest following the elections in Nigeria. The biggest worry stalking the markets is a terrorist attack on the oil facilities in
Saudi Arabia or elsewhere in the gulf. These facilities are vast and very open to terrorist attack and given a modicum of knowledge, it will be very easy to put a significant portion of production out of the market.

Gold, as is usually the case in troubled times, moved up and hit $356 per ounce before falling back slightly.

On the trade front, the international agencies are getting quite worried about the Doha round. WTO Director-General Supachai Panitchpakdi, IMF Managing Director Horst Köhler and World Bank President James Wolfensohn, in a joint statement at the WTO General Council meeting on coherence on 13 May 2003, appealed to the G-8 leaders to "provide the political guidance that is
needed to allow the trade negotiations to move forward again before the WTO
Ministerial Conference in Cancun in September". They particularly aimed their guns on the agricultural issue being critical for the next phase.

The current discussion about the CAP reform in Europe is assuming alarmingly serious significance to the future state of the world economy and French intransigence is holding this entire exercise hostage to their own weird demands.

(Dr Bhaskar Dasgupta works in the City of London in various capacities in the banking sector. He also lectures at several British Universities. He holds a Doctorate in finance and artificial intelligence from Manchester Business School and is currently working on another doctorate at Kings College in international relations and terrorism.
He will be writing a weekly Monday round-up on markets and indicators.)

First Published: May 31, 2003 12:19 IST