Markets opened the week on a relatively firm note on Monday morning, trying to recover from the decline over the last two days of the previous week. It proved to be a false start as the indices gave up by afternoon and set the tone for much of the week.

The indices saw one of the worst falls in recent months on Tuesday as traders rushed to cover their long positions ahead of the derivatives expiry on Thursday. The fall was triggered by reports of negative FII flows on the last day of the previous week and gained momentum as the session progressed. Both the Sensex and Nifty lost close to two per cent each.

The markets tried to consolidate on Wednesday as the indices turned highly volatile in search of a direction. Massive short covering in the closing hours helped the frontline indices to close with gains on Thursday, the closing day for August series of derivatives. The indices recovered some lost ground on Friday, helped by technology, cement and select oil stocks.

The Sensex lost close to 100 points and the Nifty lost 26 points or over a per cent each over the week.

Mid-caps more or less tracked the movements in frontline stocks for the first 3 days of the trading week. On Tuesday, losses in the smaller stocks were much more than index stocks. The recovery in mid-caps on the last two days of the week was equally dramatic with the index gaining well over 3 per cent in those two days. The CNX Mid-Cap 100 index lost 22 points during the week or over half a per cent, a much better performance than the frontline stocks.

Domestic economic and regulatory action

• After three months of scorching growth, infrastructure growth dipped dramatically to 0.5 per cent for the month of July from over 11 per cent a year ago and 10.4 per cent during June 2005. The major culprit was a sharp 4 per cent decline in crude oil output. Electricity generation and coal production also declined during the month. The sub par performance has brought down the infrastructure growth rate for the first 4 months of the current year to 4.2 per cent from close to 9 per cent during the previous year.

  Economy watchers and analysts were quite bullish about the growth outlook for the current year after the strong growth reported by industry during the first quarter. The deceleration in infrastructure, which accounts for more than one fourth of industrial output, is bound to affect the overall growth rate for July.

  Fortunately, the decline in infrastructure output may be a short-term phenomenon and most of the sectors may recover in a month or two. Crude output was lower because of the accident at an ONGC platform in Bombay High. ONGC has brought back the production levels to almost 80 per cent of normal levels this week.

  The decline in mining and electricity generation was more likely because of the heavy rains and flooding across the country in July. Output may limp back to normal by August though not much can be expected from these sectors because of the structural problems and lack of investments.

  The high base effect of the previous year, over 11 per cent, was another reason for the poor performance. For instance, steel, cement and coal output had reported growth rates of over 17, 8 and 7 per cent respectively during July 2004. It was almost impossible to even come close to, forget about repeating, this performance. Hopefully, the decline in infrastructure output would not have much of an impact on manufacturing growth in the coming months.

• Direct tax collections by the central government have jumped by 34 per cent during the first quarter of the current year as compared to the previous year. Advance tax payments by companies have gone up by a whopping 180 per cent. This is ample evidence that corporate earnings outlook for the full year continues to be very bullish.

  The first quarter results of listed companies were a mixed bag. The slow down in earnings growth during the quarter had worried many analysts though the first quarter is historically the weakest quarter for corporate sector. The strong growth in corporate tax payments should lessen the worries about sustainability of earnings growth.

  On the other hand, personal income tax collections were lower by 22 per cent in the last budget. In indirect taxes, collections from customs duties were higher by close to 40 per cent while excise revenues rose almost 15 per cent.

  The government expects the buoyancy in tax revenues to sustain, with revenues from the newly imposed fringe benefits tax and cash transaction tax offsetting the decline from personal income tax to some extent. The growth in tax revenues would come in handy for the government, as expenditure demands for populist programmes like the Rural Employment Guarantee Bill would add to the pressure on the fiscal situation.

• Following widespread criticism about the discretionary allotment to Qualified Institutional Investors (QIB's) in public issues, SEBI has amended the allotment norms. Henceforth, QIB's would also be allotted shares on a proportionate basis, similar to retail investors.

  Till now, allotment to QIB's was at the discretion of merchant bankers, who could allot shares to investors of their choosing, as well as the company management's, and also could deny allotment to others. Even the criteria adopted for allotment were not required to be disclosed by the merchant bankers. This had led to a situation where large institutional investors cornered sizeable chunks of shares during IPO's.

  A much more unfair provision allowed QIB's to apply for shares at the time of application for public issues without putting up any margin money; unlike retail investors who had to cough up the full amount,. This had led to a situation where the over-subscription levels were artificially boosted by large applications from institutions. There were allegations that at least some of these applications were being made at the request of issuing company promoters to give the wrong impression of high investor demand for the issue.

  Under the new norms, a margin of 10 per cent of the application amount has to be paid by the QIB's at the time of application. Though the margin is too low, at least it is a beginning. The two new provisions could bring in more order to the whole process of public issue allotment.

• SEBI has also mandated a minimum public holding of 25 per cent for all listed companies, except government companies, sick companies and infrastructure companies. Companies, which do not meet this criterion, would be given two years to meet this norm. SEBI has also stated that over a period of time this rule would be made applicable to all companies, including government companies.
• Inflation has dropped to a three year low as per the latest data available. Wholesale price inflation for the week ended 13 August declined to 3.13 per cent from 3.35 per cent for the previous week. The decline was on account of lower prices of minerals even as prices of food articles went up marginally.

  The government expects the spell of low inflation to continue for some time because of the high base effect of previous year. Even an increase in retail fuel prices is not expected to have any significant impact on price levels. The price hike is expected to be a very moderate one anyway.

Industry update

• Credit flow from the banking sector for project investments during the financial year 2004-05 was over Rs97,000 crore, according to an RBI report. The figure was almost 35 per cent higher than the previous year. This year could turn out to be another record year for project finance from banks, going by the credit growth reported by major banks during the first quarter.

  More than one third of the credit expansion during the previous year was accounted by the infrastructure sector followed by the manufacturing sector. The sustained growth in industrial investment is also evident from the increasing non-oil imports. The manufacturing sector has extracted the efficiency gains almost fully and is going in for fresh investment in capacity additions.

  The number of mega-projects announced by major companies in the core sectors like steel in the recent past is quite large. Even medium sized companies are raising money from overseas markets to fund expansion plans. All these point to a longer period of economic buoyancy led by large investments.

  The banking sector would be a major beneficiary of this investment boom, as credit demand would remain strong. Even though many companies are raising funds from overseas markets, there would be enough opportunities for domestic banks to increase their advances. Banks are already focussing more and more on core lending operations and have in fact reduced their investments in government bonds to meet the demand.

  With inflation at a three year low, the RBI may not be in a hurry to raise interest rates unless crude oil prices go through the roof and stoke inflationary pressures. The RBI can also be expected to keep in mind the need to keep this investment cycle going. However, interest rate could somewhat harden purely because of demand pressures. Banks should be able to take such pressures in their stride.

  The bigger challenge before the banks is to raise additional resources to meet the credit demand. The growth in deposits is far lower than growth in credit even in absolute terms. Hence, banks may be forced to increase deposit rates especially since other investment avenues like mutual funds and stock markets are more tax efficient. Increased competition in the industry may force the banks to take a hit on the margins. The higher volumes would more than make up for the lower spread.

  Banks would also have to raise additional capital to meet the Basel II norms. This again would not be difficult as long as the stock markets remain firm and there is a huge appetite for Indian banking stocks among foreign investors. The long-term outlook for the banking industry has never looked better.

US markets, economy and oil

• US markets were once again hit by worries of lower consumer spending and closed lower during the week. The University of Michigan survey released on Friday indicated that consumer confidence for August has declined on higher fuel prices. This is the first decline in consumer confidence in three months. This affected most of the retailing and consumer stocks and sent the major indices into a decline.

  The continuing surge in crude prices, with no signs of a decline, is also affecting market sentiment. Higher fuel prices would increase inflationary pressures and keep interest rates in an up trend. The Dow and S&P 500 lost well over a per cent each during the week and losses on NASDAQ were lower at close to three quarters of a per cent.

• US Fed chairman indicated during the week that the US central banks is paying more attention to asset prices and the liabilities that finance them. He stated that the global economic activity in the recent past has been supported by the surge in asset prices. He cautioned that asset prices could disappear fast if investor confidence is shaken in any manner.

  More conservative economists have often criticised the Fed for ignoring the bubble nature of asset prices, especially the US real estate prices. They are of the opinion that by remaining passive about the price rise, the Fed has indirectly fuelled the rally. They warn that any decline in asset prices could have a highly disruptive impact on the steady growth pace being maintained by the US economy.

• It was a week of hurricane watching in the crude oil markets as the near month futures hit another historic high of $68 to a barrel. Worries about Hurricane Katrina causing disruptions to oil production in the Gulf of Mexico led to the surge in the early part of the week. An unexpected decline in US gasoline stocks helped push the prices further.

  Crude prices gave up part of their gains later in the week, as the hurricane did not cause the expected damage. However, the same hurricane is due for a second visit over the weekend. The forecast for the current storm season in the Atlantic is not very encouraging and traders at the NYMEX would be focussing more on weather reports than demand-supply over the next few weeks.
  

*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