Narrower Trade Gap May Spur Inflation

For the U.S. economy, trade is providing both good and bad news: It is making a strong contribution to growth but is also fueling inflation.

The trade deficit shrank 0.6% to $56.45 billion in September, compared with August's $56.8 billion gap, which was revised down from $57.59 billion, the Commerce Department said.

The narrowing reflects strong global growth that is boosting demand for exports and a smaller-than-expected bill for imported oil. The lagged effect of the weakening dollar may also be playing a role: It tends to make U.S. exports cheaper, when denominated in foreign currencies, boosting their sales, and to make imports more expensive, reducing their demand.

The narrowing of the trade deficit surprised some economists, who had predicted that higher oil prices would push up imports and widen the trade deficit. But record oil prices damped demand for imported and petroleum products in September. The nation's bill for crude-oil imports was $20.38 billion, down from $21.73 billion in August.

In a separate report from the Labor Department, data showed some evidence that the weak dollar was affecting the price of imports. Import prices rose 1.8% in October after rising 0.8% in September, the department said. In the 12 months ended in October, import prices rose 9.6%, almost double the 5% rate for the 12 months ended in September.

Petroleum import prices rose 6.9% in October compared with September, and were up 41.4% from October 2006. Prices in key sectors such as capital goods and consumer products were tamer. Overall import prices excluding fuels rose 0.3% in October and are up 2.4% over the past year. Prices for imports from China jumped for a sixth consecutive month and are up 2.2% in the past 12 months.

Rising import prices could fuel inflation, one factor behind the Federal Reserve's apparent view now that it is finished cutting interest rates.

Separately, sentiment among consumers continued to slide in November. Consumer sentiment hit 75.0, down from October's reading of 80.9, according to a survey released by Reuters and the University of Michigan.

Because trade deficits subtract from U.S. gross domestic product, the lower-than-expected gaps in August and September indicate the U.S. economy likely grew even faster than thought. The government, in its first estimate for third-quarter GDP, said the economy expanded at a 3.9% annual rate.

Some economists think third-quarter GDP growth will ultimately be revised to about 5%, though they expect a sharp slowdown in the fourth quarter. The government will release more closely watched U.S. producer- and consumer-price data this coming week.

Source - WSJ

Sinking dollar, rising portfolio

Stocks have soared even as the greenback drops like a brick. That may not last. But if history is any guide, the dollar's woes will eventually weigh down U.S. stocks.

When you're traveling abroad, it's easy, if unpleasant, to grasp the impact of a sinking dollar. Now that the euro is at an all-time high against the greenback, dinner for two at a modest Paris café will set you back $200.

Simply put, when the dollar is strong against other currencies, it signifies that our economy is good and the world's faith in the U.S. is high. Conversely, a weak dollar is a sign that something's wrong, says Gordon Fowler, chief investment officer for Glenmede Investment Management.

The dollar has had declines of 25 percent or more twice in the recent past; the current fall is 36 percent since 2002 against a basket of foreign currencies. In the early 1970s, the peculiar combination of rising inflation and low demand known as stagflation was weighing the buck down. In the mid-'80s, the dollar fell amid fears the U.S. was about to be overtaken by Japan Inc. as the world's economic superpower.

This time around, the reasons for the decline are more subtle. The U.S. economy has been expanding, but that growth has not been spread evenly; now the meltdown in the housing market poses a recession threat.

Moreover, we're running a large federal deficit and a trade gap of nearly $60 billion a month. All of that puts downward pressure on the dollar.

So far that pressure has been beneficial: It's made U.S. goods sold overseas more affordable, helping to cut the trade deficit. And it is boosting the bottom lines of U.S. exporters because their foreign sales are in currencies that are appreciating.

This is a healthy, corrective development for our economy, says Eaton Vance chief economist Robert MacIntosh. Certainly the stock market seems comfortable with the trend. The S&P 500 has risen 35 percent in the five-plus years that the dollar has been on the decline.

Dollar up, stocks down?

But the flip side of our stuff being cheaper overseas is that imports are more expensive here. And we do like to import. Eventually that means rising inflation. In both the early '70s and mid-'80s, inflation related to a falling dollar led the Federal Reserve to raise interest rates. That stabilized the buck - and sank the stock market. (See the graphic to the right.)

Whenever the dollar turns, it will probably mark the beginning of the next bear market, says Christopher Orndorff, head of equities for Payden & Rygel, an asset management firm in Los Angeles.

There are scenarios that Orndorff foresees that could allow the market to evade this fate. First, Fed chairman Ben Bernanke could prove more artful than his predecessors at fighting inflation without killing stocks. Or the dollar could strengthen without the Fed's intervention, not necessarily because of good news for the U.S. but because economies in Europe or Asia run into trouble.

There is, however, a longer-term bearish outlook for the dollar too. In this scenario, which Warren Buffett worries about, overseas investors financing our fiscal and trade deficits by buying Treasuries grow impatient with the sinking buck - which, after all, is worth less in their home currencies.

So they sell, and then buy investments in other currencies, further weakening the dollar and forcing up interest rates here. That, in turn, chokes off the U.S. economy, so the overseas investors sell even more, weakening the dollar again. The cycle then repeats. If that's what unfolds, economic superpower really will end up no longer being used near the words United States.

Source - CNN Money

India slips in competitive index

India has slipped six notches to 48 over last year in a global ranking of competitiveness spread across 131 countries. It has lost ground due to lack of macroeconomic stability and proper infrastructure facilities, the World Economic Forum (WEF) said in its survey.

Some consolation can be derived from the fact that India is ahead of Russia (rank 58) and Brazil (72), but behind China (34) in the WEF’s Global Competitiveness Index 2007-08, released here today.

The United States topped the list as the world’s most competitive economy. India has also been ranked third in terms of domestic market size.

One reason for India’s rank dipping from 42 last year was due to nine new countries being included in the survey this year, taking the total number to 131.

The quality of the business environment in India has improved tangibly in recent years, with increased efficiency of the goods, labour and financial markets, and greater innovation and sophistication of company operations.

However, a number of weaknesses persist which need to be addressed especially in the area of infrastructure, said Fiona Paua, head (strategic insight teams), WEF.

India has also received positive remarks for the state of its business clusters and the availability of local suppliers, as well as its reliance on professional management rather than friends and relatives.

Though the WEF lauded India’s quality of management schools (ranked eighth globally) and the availability of top-quality scientists and engineers (ranked fourth), it also highlighted the country’s poor performance on various social indicators infant mortality (106), life expectancy (104) and malaria incidence (101).

Enrolment rates in the educational system remain low, with primary education also receiving poor marks for quality, the WEF said.

The report also said that a high government deficit was dragging the country down in the competitive ranking. A lack of macroeconomic stability is a competitive weakness, with a government deficit that places the country 125th and inflation in excess of 6 per cent at a time when inflation has been much reduced around the world, it added.

Source - Business-Standard

Dollar Falls to Record Low Versus Euro Before Fed Rate Meeting

The dollar fell to a record low against the euro on signs a slump in housing is hurting the U.S. economy, bolstering the case for the Federal Reserve to lower interest rates next week.

The U.S. currency has weakened three straight weeks on speculation the housing recession will spread to consumers and erode corporate earnings. Sales of previously owned homes declined last month by almost twice the rate economists forecast, and consumer confidence dropped to the lowest since May 2006.

The dollar will continue to fall as long as the Fed is cutting interest rates, said Shaun Osborne, chief currency strategist at TD Securities Inc. in Toronto.

The dollar weakened 0.6 percent this week to $1.4393 per euro. It touched an all-time low of $1.4395 per euro yesterday and declined against 15 of the 16 major currencies this week. The U.S. currency dropped 0.3 percent this week to 114.19 yen.

The U.S. Dollar Index, measuring the dollar's performance against six major peers, has lost 8 percent in 2007 and set a record low of 76.977 on Oct. 26.

Interest-rate futures traded on the Chicago Board of Trade show a 92 percent chance the Fed will lower its benchmark overnight rate a quarter-percentage point to 4.50 percent on Oct. 31, after reducing the rate a half-point on Sept. 18 in the first cut since 2003. Futures show an 8 percent chance of a half-point cut on Oct. 31.

Slowing Economy

A government report on Oct. 31 may show U.S. gross domestic product slowed to an annualized 3.1 percent growth rate last quarter, from a 3.8 percent clip in the prior quarter, according to the median estimate in a Bloomberg News survey.

Sales of previously owned homes fell 8 percent last month, while the median price dropped the most in almost a year, the National Association of Realtors said this week. Countrywide Financial Corp., the biggest U.S. mortgage lender, reported its first quarterly loss in 25 years yesterday as borrowers defaulted.

Oil rose above $92 a barrel for the first time in New York this week, pushing Canada's dollar to the highest since 1974 versus the U.S. dollar.

The yuan had its biggest weekly advance in six weeks, to 7.4877 per dollar, reaching the strongest since China ended a peg to the dollar in July 2005. Finance ministers and central bankers from the Group of Seven major industrialized nations last week called for a faster appreciation in the yuan, which they contend is artificially cheap.

A recovery in global stocks this week gave investors confidence to resume carry-trade bets, where they buy assets in countries with high yields, using loans in low-yielding currencies such as the yen. The Standard and Poor's 500 Index gained 2.3 percent this week, following a 3.9 percent tumble the week before.

The yen fell 0.3 percent this week to 164.34 per euro, and dropped 2.2 percent versus the New Zealand dollar.

Cabinet clears sugar industry sops

The government today announced a slew of measures aimed at helping the sugar industry.

These include subsidised loans to sugar mills to help them clear dues of farmers and making mandatory the blending of 5 per cent ethanol in petrol with immediate effect across the country, barring the North East, Jammu and Kashmir and the island territories.

It also allowed sugar factories to produce ethanol directly from sugarcane juice to augment its availability and reduce oversupply of sugar.

At the same time, 10 per cent blending has been made optional from this year, but this would become mandatory from next October.

A uniform nation-wide purchase price of Rs 21.50 per litre (ex-factory) for supply of ethanol for the next three years was also decided at a meeting of the Cabinet Committee on Economic Affairs here today.

The Indian sugar industry is facing its worst crisis, with mills not even able to recover the cost of raw material. This year's production, at 28 million tonnes, is 45 per cent higher than last year's 19.2 million tonnes.

Consequently, sugar prices have dropped sharply and most companies have incurred losses in the last two quarters. Mills have not been able to pay the cane prices to farmers.

In other decisions, the Cabinet also approved conversion of outstanding loans on account of harvesting and transport charges and short margins on sugar stocks, as appearing in the books of the sugar mills on April 1, 2007, into term loans up to a maximum period of five years, without any reduction in the existing rate of interest, and to provide higher interest subvention from budgetary support to the tune of Rs 600 crore.

The CCEA today gave its approval for providing loans to sugar mills from the banks under special guidelines. They would be entitled to loans of an amount equivalent to central excise duty paid by them, Finance Minister P Chidambaram told reporters after the meeting.

The government also gave its approval to extend the moratorium on outstanding term loans as on April 1, 2005, announced in September 2005 for co-operative sugar mills, from two to up to five years (reckoned from April 1, 2005) and to include co-operative sugar mills, not included in the earlier package, for availing the benefits of the earlier package.

The CCEA also extended export subsidy by one more year from April 19, 2008 to April 18, 2009, to target an additional export of 3 million tonnes of sugar.

It also decided to reduce Customs duty on denatured alcohol from 7.5 per cent to 5 per cent and on molasses from 10 per cent to 5 per cent.

The measures will be implemented once the mandatory 5 per cent ethanol blending comes into effect. It also approved extending the export assistance scheme under Sugar Development Fund to April 2009.

Prices are expected to fall further with yet another record production, projected at over 30 million tonnes, in 2007-08. Annual domestic demand hovers around 20 million tonnes.

The Union government has already announced incentives such as creation of a 5 million tonnes buffer stock and export subsidy (at a rate of Rs 1,350 a tonne for coastal sugar mills and Rs 1,450 a tonne for the non-coastal mills) to help the beleaguered industry.

Source - Business standard

Can Fed support another rate cut?

Global equity markets, especially emerging markets, have surged to lifetime highs after last month's US Fed rate cut. But many of these markets are close to bubble territory while investors are ignoring the growing risks.

Ben Bernanke did what any sensible central banker would do when faced with demand slowdown in the economy. Size of a rate cut is always debatable, but it is well accepted that such measures should surprise if monetary policy is to be effective. A full-blown crisis in the financial markets and tight liquidity would have worsened the already weak outlook for the US economy.

Nobody likes a recession, not even central bankers, especially ahead of a presidential election. As a columnist said in the Financial Times yesterday, "in democracies bad stuff is outlawed" if politicians want to be re-elected.

But a large interest rate cut is like giving first aid to an accident victim, which in this case is the US economy. First aid is delivered without knowing or checking the full extent of injuries and it is often difficult to predict whether the patient's condition will improve. All that is known is that the victim is injured and will take some time to recover.

If the economy is weak, with increasing risks of it turning even weaker, and emergency support has been given in the form of an interest rate cut, why are markets so bullish? Strange as it may sound, but it is because conditions may get even worse and more rate cuts may follow!

Rate cuts bring the omnipotent force called liquidity into the markets and everyone will be happy and more prosperous. Declining corporate performance in a weak economy and soaring stock valuations be damned.

On the other hand, The Federal Reserve's decision last month to cut interest rates by a larger-than-expected half-percent point sent the already-weakening dollar to an all-time record low against a basket of six major currencies. In the third quarter, the euro appreciated more than 5% against the dollar, most of the gains coming in September alone.

Weakness in the dollar means prices of imported goods, particularly oil, will go up, raising the risk of inflation. American consumers will be paying more soon, with the looming threat of paying even more later on.

"The inflation risk from higher import prices will be the dominant initial effect," said Howard Chernick, an economics professor at Hunter College in New York. "The most immediate effect is imports denominated in dollars -- mainly oil. We already saw a spike in oil prices. So a bit down the line, that's 10 to 15 cents more per gallon of gas at the pump."
A weaker dollar can help narrow the U.S. trade deficit by making America's exports more affordable abroad.

Yet it could also make funding those imbalances more difficult. The U.S. has to attract billions of dollars a day from foreign investors, and a weakening currency makes dollar-based assets less attractive because of the consequences it can have on their long-term value.

That fear of inflation came into focus on Friday when a top Fed official suggested policy-makers have already cuts rates enough, a view reinforced by fresh data showing U.S. employment grew at a steady clip in September.

Inflation, as the late economist Milton Friedman once wrote, is taxation without legislation. Rising prices rob consumers of purchasing power, destroying the value of their savings over time.

Inflation turns savers into losers, at a time when America desperately needs more savers to fund its imbalances -- particularly if foreign investment starts to taper off. But fears of rising prices will keep consumers cashing their paychecks and heading to the mall, rather than depositing the funds in accounts whose returns might lag the inflation rate.

Having said this, What if Ben Bernanke decides that financial markets have partied enough, and decides to focus more on his pet peeve — inflation? Then he may hike interest rates or keep them steady and the markets will be in for a huge disappointment. We all know what happens when markets are disappointed, especially when the indices are at lifetime highs — investors panic.

Let us wait to see what will Fed vote for a rate cut to save recession ahead of presidential election or to save inflation in the next meeting?

- Compiled from various sources

India Trade Deficit Widened to $6.8 Billion in August

India's trade deficit widened in August as companies stepped up imports of oil and machinery to meet demand in the world's second-fastest growing major economy.

The trade deficit jumped to $6.8 billion from $5 billion in July, the Ministry of Commerce and Industry said in a statement in New Delhi today. Imports rose 32.6 percent to $19.5 billion. Exports in August grew 18.9 percent to $12.6 billion.

Imports are climbing as General Motors Corp., Honda Motor Co. and other automakers build new factories in India to cash in on the nation's auto demand, while refiners are buying more crude oil to fuel power generation. Exports have been hurt by the fastest gain in the nation's currency in at least 33 years.

`India's trade deficit is a result of its unprecedented economic growth,'' said D.H. Pai Panandiker, president at RPG Foundation, an economic policy group in New Delhi. ``The deficit is also under pressure because exports turned weak after the strong gain in the currency.''

India's rupee, Asia's best performer, has climbed 11.4 percent this year as international capital flows to the world's second-fastest growing major economy after China. India's economy grew 9.3 percent in the three months to June 30.

Non-oil imports in the April-August period rose 42.9 percent to $66 billion and oil imports gained 8.3 percent to $25.9 billion, today's report said. The trade deficit between April and August widened to $32.5 billion from $19.9 billion in the same period last year.

Rising salaries and borrowing from commercial banks have fueled spending by consumers in the world's second-most populous nation. Hewitt Associates Inc. forecasts salaries in India will climb an average 14.5 percent in 2007, the steepest gain in Asia for the second straight year.

General Motors, Honda, Volkswagen AG and half a dozen other companies plan to spend at least $6.6 billion on new factories. All are betting on a country where 7 people in 1,000 own a car, compared with 450 per 1,000 in the U.S. and 500 per 1,000 in Western Europe.

India's manufacturing growth accelerated in September as rising incomes spurred consumer spending, ABN Amro Bank NV said today. Manufacturing makes up a fifth of India's $854 billion economy.

The bank said its purchasing managers' index rose to 59.1 last month, the highest level since October 2006, from 57.9 in August. A reading above 50 indicates factory output gained.

Source - Bloomberg