The week had the worst possible start as the indices saw one of the biggest drops this year and ended with losses of over 2.5 per cent each. Hopes of a pre-budget rally receded and many frontline stocks tumbled as traders rushed in to wind down their F&O positions. Stocks of companies like Hindalco and Suzlon, which announced major overseas acquisitions, were brutally beaten down on concerns of higher debt and decline in margins in the medium term.

Tuesday saw considerable volatility in the indices as subdued global cues led to a sharp fall in early trades. Sensex dipped close to 14000 and the Nifty went below 4000 as telecom and select metal stocks gave up further ground. The indices recovered later, only to give up once again in the afternoon.

The CRR hike led to a sharply lower opening on Wednesday as banking stocks lost substantially. Some of the PSU banking stocks were the worst hit with SBI losing more than 6 per cent. Private sector banking stocks were not spared either while auto stocks lost ground on concerns that higher interest rates would affect demand. A recovery in metal and telecom stocks in the afternoon helped the indices to limit their gains.

After declining consecutively for four sessions, the indices bounced back strongly on Thursday. Strong gains across most global indices triggered the pull back in the morning and gathered momentum later. The beaten down stocks were the best performers as many of them recovered a substantial part of their losses from earlier this week.

Sensex lost 183 points or 1.26 per cent during the week and the Nifty gave up 41 points or 0.98 per cent over the week. Losses on the Nifty were lower during the week as stocks like ONGC and Bharti, which have a higher weight on the Nifty, did relatively better.

Mid-caps and small-caps also lost ground during the week as some of the best performers in recent weeks came under heavy profit booking. Mid-cap and small cap indices tumbled on Monday and ended with losses of over 3.5 per cent each. They recovered part of their early losses on Tuesday before ending with modest gains on Wednesday. Thursday saw a sharp recovery in the smaller stocks, helped by the gains in large caps. CNX Mid-Cap 100 index closed the week with losses of 47 points or 0.89 per cent for the week.

Domestic economic and regulatory action

• Wholesale price inflation for the week ended 03 February continued to rise and touched 2-year highs of 6.73 per cent from 6.58 per cent reported for the pervious week. Prices of both primary food articles and manufactured products continued to rise this week as well. Inflation for the same week of last year was at a much lower 3.98 per cent. Within the primary food group, prices of select meat and poultry products saw sharp increases. Select oil seeds and pulses were costlier while prices of select cereals, including wheat, declined.

  The inflation data released on Thursday seems to have been made available to the RBI even earlier as the central bank went in for a further 50 basis point increase in CRR. The hike would drain out an additional Rs14,000 crore of funds from the banking system and some of the larger PSU banks have already hiked their lending rates. Continued rise in interest rates may have some impact on lending, especially retail loans. There are already reports of residential real estate prices taking a breather in some of the larger cities after the run away rise in recent years.

  The government also went into a fire-fighting mode to tackle rising inflation and cut retail fuel prices. Even the meagre margins the oil marketing companies were making on petrol have now been wiped out while the under-recoveries on other products would now increase even further. The impact on companies would be limited, as the government would partly compensate them through oil bonds. For the government, oil bonds are a very convenient way to defer current subsidies to future years. But, the impact of such bonds on the fiscal health of the government in coming years could become an area of concern.

  Among other measures, the government has also banned the export of wheat and has put restrictions on export of onions. Import of select commodities has been made easier to ease the situation. Though the Left parties are demanding a ban on forward trading in commodities, it is unlikely that the government would take such a drastic step.

• Industrial growth for the month of December was better than expected, though lower than the phenomenal growth reported for November. Industrial output expanded 11.1 per cent over the same month of previous year, taking the growth for the first nine months of the financial year to 10.8 per cent. Manufacturing continued to lead with a 11.9 per cent growth while electricity generation surprised with a 9.3 per cent growth. Mining output increased by 3.8 per cent.

US markets, global economy and oil

• US markets recovered this week on signs of slowing inflation and more speculation about large mergers. The Fed chairman's statement about lower inflation led to hopes of an interest-rate cut, something that the market had given up. Speculation about mergers and acquisitions involving such large companies like Alcoa and Chrysler kept the trading interest alive.

  US indices were subdued on Monday before picking up strength and rallying on Tuesday and Wednesday. They ended with modest gains on Thursday and recovered from early weakness on Friday. The Dow gained close to 1.5 per cent for the week while S&P 500 added 1.2 per cent. Technology stocks also did well despite some weakness in Microsoft towards the end of the week and the NASDAQ gained 1.5 per for the week.

• US Fed chairman stated this week that inflationary pressures in the US economy are beginning to diminish, a much more positive statement than financial markets were expecting. However, he cautioned that the Fed would need more time to be confident that underlying inflation is moderating. The Fed is not lowering its guard on inflation as tight labour market conditions still have the potential to worsen the situation.

  The Fed chairman maintained that the US economy would stabilise to moderate growth rates during the current year and the next. The housing sector, which has been the biggest drag in recent quarters, is showing some signs of stabilising though the sector would continue to face some pressures for the rest of the year, he added.

  Producer price inflation for the month of January in the US supports Fed's assessment of inflationary pressures. Overall prices for the month declined by 0.6 per cent while core inflation – after excluding food and energy prices – went up by a modest 0.2 per cent. The decline in crude oil prices was mostly responsible for the drop in prices.

  However, the Fed's optimism about the housing market looked somewhat premature after the release of data showing a decline in new housing starts for the month of January. In fact, new housing starts for the month were the worst in nearly nine years. Economists have cited cold weather, which would have delayed construction, as the main reason for the worse than expected drop. It would take more data in the coming months to determine whether the sector has finally stabilised. After all, piled up inventory of unsold homes continues to be a big problem for the residential construction sector.

• The Japanese economy expanded at a better than expected 1.2 per cent, or 4.8 per cent annualised, for the last quarter of 2006 over the precious quarter. This is the best quarterly growth for the Japanese economy in nearly three years and has helped allay fears of a slow down. Despite the good showing by the world's second largest economy in recent years, many economists were sceptical whether it can sustain the growth this year. Any slowdown in Japan would have affected overall global growth, especially if the prospects of US economy remains subdued. However, the strong growth has increased the possibility of an interest rate hike by Bank of Japan.

  Japan has faced some criticism in recent months that much of the growth has been achieved by keeping its currency artificially low to help exports. There is rising pressure on Japan to let its currency appreciate, especially since it is forcing other countries in the region to adopt the same policies to maintain their competitiveness. As other countries in the region do not have the capacity to sustain such policies, it is feared that many governments in the region would overstretch themselves and push the region as a whole to the brink.

• Crude oil prices were range bound during the week. The statement by Saudi officials that no further production cuts are required led to a decline on Monday. Prices recovered on Tuesday after the International Energy Agency increased its global demand forecast and was followed by a modest correction on Wednesday.

  Warnings about an escalation in violent attacks against oil assets in Nigeria led to some gains on Friday and prices moved back above $59 per barrel. Near month futures on the NYMEX lost more than 0.5 per cent for the week and settled at $59.39 per barrel on Friday.

*Disclaimer: The author may have positions in the stocks 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.