Ill-advised on inflation

The government's assessment is way off the mark

The bond market was not amused by the chief economic advisor's recent remarks on inflation turning out to be so far off the mark. Dealers who had interpreted the assurances as a buying opportunity were left with heavy losses on their hands.

This time, unlike in the previous three weeks, the index went up sharply, primarily on account of higher food and iron ore prices. The trouble is that the rise in oil and steel prices will push up inflation even further in the next few weeks. What's more, there's a cascading effect to the rise in oil and raw material prices""-for example, higher crude prices led to Reliance Industries increasing the prices of its petrochemical products recently, while the rise in iron ore prices has since been followed by a hike in steel prices.

Should the RBI increase interest rates? One view is that there's no need for that, as liquidity in the money markets is substantial, and because the rise in inflation is due to cost-push factors, which the RBI can do little about. Some market players point out that much of the spike in oil prices is due to the US stockpiling crude oil.

Since there's a limit to stockpiling, this view holds that it's only a matter of time before crude prices come down. And domestically, the effect of a higher base will lead to the inflation rate coming down by September. As proof, they point to the swap market, where rates have not gone up so far and so fast as in the government securities market.

On the other hand, now that we have a global economy, our inflation rates too will have to go up in line with global trends""""China's inflation moved up to a multi-year high of 5 per cent in June, while US inflation was 3.27 per cent for that month.

In this context, the RBI's decision to issue floaters is welcome""-with a yearly reset clause, the market perceives that as a short-term bond, and it should help calm the market.

Oil companies

Domestic oil refining and marketing companies see their profits eroding with the latest string of rallies in crude prices "" from $ 42 per barrel to close to $ 44.73 per barrel (US light crude). At present, oil companies are operating at the upper limit of the 10 per cent price band, implying that if crude prices go up any further, they will have to shell out the difference from their own pockets, if the consumer prices are not hiked in line with costs. As a senior executive with an oil company points out, "this is a unique situation where the government wants to subsidise products but not share the cost of subsidy."

It's not just high crude prices that's the problem""-the depreciation of the rupee is also having an impact, since the price of crude in rupees increases even further. The net effect is that oil companies need even more funds. In a situation where the government is reluctant to raise product prices, one alternative for the oil companies is to borrow more.

But rising interest rates in the money markets will result in a higher cost of borrowing for the companies. What's more, interest rates have hardened globally, which means that external borrowings too are more expensive. The net result of higher crude prices, rupee depreciation and higher interest rates is a triple whammy for oil companies.

TCS shows there's money in the market

There's far more money waiting to enter the market than most people think. Consider the TCS IPO: at close to Rs 5,000 crore, it was felt that the issue could test the liquidity in the system. Nothing of that sort has happened. On a cumulative basis, the issue has received bids close to Rs 50,000 crore. Retail (Individual) investors alone bid for shares worth Rs 13,000-14,000 crore. And FII bids amounted to around Rs 17,000 crore.

Another view was that money could rotate from other front-line tech counters such as Infosys and Wipro into TCS. But even this has not happened. Both Infy and Wipro's share prices have gained since the TCS issue was open for subscription. NSE's CNX IT index gained over 4 per cent during the period.

What's more, it looks like the issue price will be fixed at the upper end of the price band, Rs 900. The response to the IPO has been good, and is a thumbs-up for the tech sector. Recent client wins and recruitment figures show that the sector's good performance is expected to continue. TCS, being the market leader, would have been one stock investors didn't want to miss in their portfolios.

The overwhelming response to the IPO shows that in doing so, investors are okay with the fact that TCS Limited, being a new entity, has no cash on its books and is valued at around 37 times its book value. Besides, going by its past record, its earnings are lumpy "" net profit had jumped 46 per cent in FY04, but had fallen 1 per cent in FY03. A true picture how the markets view all this will emerge only when the stock lists.

With contributions from Hemangi Balse and Mobis Philipose