VZCZCXRO2121
RR RUEHAST RUEHCI RUEHDBU RUEHLH RUEHNEH RUEHPW
DE RUEHBI #0371/01 2530548
ZNR UUUUU ZZH
R 100548Z SEP 09
FM AMCONSUL MUMBAI
TO RUEHC/SECSTATE WASHDC 7450
INFO RUEHNE/AMEMBASSY NEW DELHI 8677
RUEHCG/AMCONSUL CHENNAI 2115
RUEHBI/AMCONSUL MUMBAI 2678
RUEHCI/AMCONSUL KOLKATA 1903
RUEHRC/DEPT OF AGRICULTURE USD FAS WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEAIIA/CIA WASHDC
RHEHAAA/NSC WASHINGTON DC
RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE

UNCLAS SECTION 01 OF 03 MUMBAI 000371 
 
SIPDIS 
 
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TREASURY PLEASE PASS TO FEDERAL RESERVE 
 
E.O. 12958: N/A 
TAGS: EAGR ECON EFIN EIND EINV IN
SUBJECT: MUMBAI ECON MASALA:  ECONOMISTS EXPRESS CONCERN OVER FISCAL 
DEFICIT, DROUGHT, AND INFLATION; INTEREST RATE FUTURES LAUNCHED 
 
MUMBAI 00000371  001.2 OF 003 
 
 
¶1.  Mumbai Econ Masala Contents: 
 
 
 
n  Economists Point to Rising Production and Capex as Positive 
Economic Indicators~. 
 
n  ~But Note Concerns of Rising Inflation and Fiscal Deficit 
 
n  Deficit Continues to Concern Economists 
 
n  Interest-Rate Futures Reintroduced in India 
 
 
 
 
 
Economists Point to Rising Production and Capex as Positive 
Economic Indicators~. 
 
-------------------------------------- 
 
 
 
 
 
¶2.  Mumbai-based economists have maintained their GDP estimates 
for FY2009-10 in the 5.8-7.0 percent range despite drought 
conditions in parts of the country which are likely to affect 
agricultural growth.  Some believe that a sharp rise in factory 
output, among other factors, could help mitigate the effects of 
a poor monsoon.  The industrial production growth, led by a 
recovery in manufacturing sector, accelerated to 7.8 percent in 
June from 2.7 percent in May.  (Note:  Manufacturing sector 
contributes to two-thirds of the industrial production numbers. 
End Note.)  The purchasing managers' index, or PMI (another 
measure for manufacturing output), remained over 50 for the 
fifth consecutive month, indicating a rise in factory 
production, although it dipped to 53.2 in August from 55.4 in 
July.  However, Sonal Varma, the India Economist at Nomura 
Advisory Services, warned that quick growth in manufacturing 
activity as indicated by the production data might not be 
sustainable.  She explained that the first quarter mainly saw 
destocking activities, as firms tried to sell existing stocks. 
However, now firms are building up new stocks, anticipating a 
rise in demand spurred by government spending, resulting in a 
rise in production numbers. 
 
 
 
 
 
¶3.  Varma indicated that overall, Indian businesses are now 
finding the environment for financing more benign although banks 
have not yet returned to pre-crisis lending levels.  Currently, 
banks in India are storing Rs. 1.2 trillion (USD 24.62 billion) 
with the RBI on a daily basis, as compared to a daily average of 
just Rs.300 billion (USD 6 billion) prior to September 2008. 
She acknowledged that lower credit demand, which had not 
returned to pre-crisis levels, also contributed to the rise in 
bank deposits with RBI.  Though businesses were not announcing 
large expansion plans, she admitted, that there was a pickup in 
capital expenditure (capex).  A firm's investment decision is 
dependent on its ability to raise funds and future demand 
prospects, both of which have eased, she said.  Vyas, in 
agreement, added that huge capacities had been built-up in 
cement, power and steel sectors.  These companies had funded 
their capex plans mainly from internal accruals.  According to 
an analysis carried out by Mint, a leading business newspaper, 
there was a clear rise in capex as compared to the previous 
slowdown in 2002-03.  Net fixed assets grew by 15.5 percent in 
2008-09, slower than the growth of 20.4 percent in the previous 
year, but still rather high.  RBI data also indicate that capex 
sanctioned by banks and term lending institutions has grown by 
25 percent in 2008-09.  Varma added that the busy credit season 
starting in October will be a better indicator of general market 
trends. 
 
 
 
 
MUMBAI 00000371  002.2 OF 003 
 
 
 
 
 
 
~But Note Concerns of Rising Inflation and Fiscal Deficit 
 
--------------------------------------------- ------------ 
 
 
 
¶4.  The consumer price index (CPI), the Indian inflation rate 
based on retail prices for industrial workers, rose 11.98 
percent in July 2009 from 9.28 percent in June, mainly due to 
rising food prices.  Recognizing this, the Reserve Bank of India 
(RBI) in its July monetary policy review raised its inflation 
forecast for this fiscal year 2009-2010 to five percent from 
four percent, although India's benchmark inflation rate -- the 
Wholesale Price Index (WPI) has become negative due to the base 
effect of last year's high energy prices.  Varma believes that 
the RBI sounded "hawkish" on inflation and would take steps to 
remove liquidity from the banking system.  (Note: The RBI has 
infused liquidity of about USD 115 billion since September 2008. 
 End Note.)  She believes that the RBI would increase the cash 
reserve ratio (CRR) -- the amount of deposits the RBI requires 
banks to keep with the central bank -- and other policy rates by 
January 2010.  She pointed out that a 1 percent CRR increase had 
the potential to absorb about USD 5.7 billion from the economy. 
However, Mahesh Vyas, Managing Director and CEO of the Centre 
for Monitoring the Indian Economy which is an economic research 
organization, warned that a premature exit of monetary measures 
could jeopardize both the nascent recovery and the government's 
huge borrowing plan.  He explained that the rise in prices was 
due to supply side pressures and therefore should not warrant an 
interest rate hike. 
 
 
 
Deficit Continues to Concern Economists 
 
--------------------------------------- 
 
 
 
¶5.   In conversations with Congenoffs, Mumbai-based economists 
are expressed concern about the growing fiscal deficit and are 
keen to know the government's plan to "unwind" its borrowing 
programs.  The government plans to borrow a record Rs. 4.51 
trillion (USD 92.53 billion) to meet its fiscal deficit of 6.8 
percent of GDP.  Until now, the RBI has sold Rs. 2.61 trillion 
(USD 53.55 billion) worth of bonds.  The increase of government 
paper has led to a problem of supply management in the bond 
market.  The yield in the benchmark 10-year government 
securities soared from five percent in April 2009 to 7.35 
percent in August 2009.  Varma added that banks had requested 
the RBI to allow the bonds purchased to be classified under the 
held-to-maturity category so that they do not have to provide 
for the losses on a mark-to-market basis.  Moreover, banks fear 
that drought-related measures will put additional pressures on 
the fiscal account, with states like Bihar demanding relief 
amounting to 0.5 percent of GDP. 
 
 
 
Interest-Rate Futures Reintroduced in India 
 
-------------------------------------------- 
 
 
 
 
 
¶6.  On 31 August, India expanded the range of risk management 
financial instruments by reintroducing the trading of 
interest-rate futures (IRF) to enable companies and investors to 
hedge against interest rate fluctuations.  An IRF contract is a 
financial derivative with an interest-bearing instrument as the 
underlying asset.  It is an agreement to buy or sell the 
underlying debt instrument at a future date at a price decided 
in advance. 
 
 
MUMBAI 00000371  003.2 OF 003 
 
 
 
 
¶7.  IRFs were first introduced in India in 2003, but were 
discontinued within months of the launch due to thin to zero 
trading volumes.  Two systemic deficiencies were cited:  the 
pricing system was considered too complex (based on a zero 
coupon yield curve which is not directly observable and hence 
considered theoretical), and banks, who hold a large volume of 
government securities and might have been the biggest traders of 
IRFs, were only allowed to hedge but not trade in IRFs.  Now, 
after six years, the regulators, the RBI and the Securities 
Exchange Board of India (SEBI), have redesigned the IRF 
contracts which are now based on the 10-year government bond, 
bearing a notional interest rate of 7 percent, with half-yearly 
compounding.  In addition, the new guidelines allow wider 
participation, including banks (allowed to trade for themselves 
and not on behalf of their clients), companies and foreign 
institutional investors (not for speculation but only to the 
extent they have an underlying exposure). 
 
 
 
¶8.  The National Stock Exchange (NSE), India's largest exchange 
in terms of daily equity turnover, was the first to begin 
trading.   It recorded 1,475 trades resulting in 14,559 
contracts valued at Rs. 2.67 billion (USD 55 million), with the 
heaviest volume in the shortest maturity.  (Note: The share of 
IRFs in the global derivatives market was about 20 percent, 
totaling to USD 1,400 trillion in 2008.  End Note.)  The Bombay 
Stock Exchange, already approved by the regulator for IRF 
trading, is set to start trading in a few weeks. IRFs are the 
first major product to be launched by Indian exchanges after the 
introduction of currency futures in August 2008, which currently 
has a daily turnover of more than USD 2 billion. 
FOLMSBEE