RBI Governor D Subbarao has said the central bank cannot escape from the challenge of weighing the growth-inflation trade off in determining its monetary policy stance
US President Barack Obama’s popularity ratings got a boost following the death of Osama bin Laden, but back home if one were to run a similar poll for Duvvuri Subbarao, the outcome would be anybody’s guess. For the ninth time since March 2010, the 22nd governor of the Reserve Bank of India has hiked the repo rate in a bid to counter raging inflation, which threatens to derail India’s growth engine. Subbarao’s hawkish stance is understandable, given that average headline inflation was at a 16-year high in the just-concluded FY11, and continues to stay elevated at 9%, two months into the new fiscal year. Though the 62-year-old Subbarao has been critical of the inflation-targeting school of thought, he has time and again found himself doing that. . Not surprisingly, the post-policy remarks reveal Subbarao’s predicament. “The Reserve Bank of India cannot escape from the difficult challenge of weighing the growth-inflation trade off in determining its monetary policy stance.” The unwilling trade-off has then been made: the central bank has slashed the country’s GDP growth forecast for FY12 to 8% against the government’s projected 9%. For now, RBI estimates inflation will stand at an average 9% in the first half of FY12 and expects it to fall to around 6% by March 2012. Making the job easier for the RBI is the unequivocal support from the government. “Autonomy does not mean doing the opposite of what someone else says. What is heartening about the recent policy is that the government and the RBI are autonomously in agreement,” read a statement made by Kaushik Basu, Chief Economic Advisor to the Finance Ministry, post the recent hike. Though Subbarao has Basu’s support, India Inc, in general, is miffed by the RBI move . Already smarting from the rise in commodity prices, Corporate India will now have to contend with a higher interest outgo on its loans, further impacting their bottomline. The 50 basis repo rate hike means the rate at which the RBI lends money to banks has risen to 7.25% and 6.25% will be the rate banks get for parking their funds with the central bank. The hike in repo rates forces banks to jack up their own lending rates to personal and corporate borrowers, thus making overall borrowing more expensive.
Trial By Fire
Corporates are already feeling the pinch. According to a recent survey by Ficci, most respondents expect manufacturing growth to moderate because of higher financing costs. About 34% respondents reported higher cost of borrowing and 48% reported that they might re-consider expanding capacity because of the same. . The survey showed that prime lending rates of banks were already ruling at 12.75-13%. Now, the risk is that the rates could go up further. Taking it on the chin is the beleaguered real estate sector, which is already grappling with weak demand and the legacy of high leverage. Pradeep Jain, Chairman, Confederation of Real Estate Developers’ Association of India (Credai), feels the rate hike is harsh. “This will aggravate the cash crunch the industry is facing. The apex bank must think about the industrial growth, which has moderated in last few quarters. Taking funds out of the market cannot be the only solution to tame inflation.” His view is echoed by other business bodies as well. “The industry is already reeling under the impact of rising raw material costs and an increase in interest costs will be an added burden,” says B Muthuraman, vice-president, Tata Steel, and president, Confederation of Indian Industry. Some like Arun Singh, senior economist, Dun & Bradstreet India, feel that higher rates will significantly affect the entire economic environment in the country. “The RBI has focused on taming inflationary pressures at the cost of impacting growth—as an aggressive hike in the policy rate is likely to impact not only demand but also investment,” he says. Corroborating Singh’s views is the slowdown in the pace of new investments. According to economy think-tank CMIE, new investment announcements stood at Rs 2.63 lakh crore in recent March quarter against Rs 2.92 lakh crore in the preceding quarter. According to CMIE, the average value of new investment announcements in the past three quarters, at about Rs 3 lakh crore per quarter is nearly half the Rs 5.8 lakh crore per quarter average in the preceding three quarters. That is bad news as the recent Ascon-CII survey showed that of the 121 sectors, there are 55 sectors that still have moderate to negative growth. Manoj Gaur, executive chairman, Jaiprakash Associates, part of the Jaiprakash group that has interests in roads, power, cement, and real estate, agrees. “Inflation is a matter of concern, but what is worrisome is that if interest rates start increasing then this would effect infrastructure development,” says Gaur, who feels rising rates will make it all the more difficult to raise debt within the country.
Little Headroom
Rating agency Fitch has already raised the red flag. According to the agency, if interest rates remain at very high levels over the life of project loans for power projects, debt service coverage ratios could come under pressure. In extreme situations where a project has just drawn a loan and the applicable interest rate has increased by 300 basis points, Fitch expects additional cost of the project to be in the region of 2-3.5%, depending on the drawdown schedule and gearing level. Gaur, hence, believes higher rates could impact the viability of ventures as these costs cannot be easily passed on to the end-consumer. Already, with coal prices up 35%, the fear is any such step would lead to an increase in power tariff by 13 paise per unit. In the case of real estate, developers are already reeling under the rise in prices of cement and steel, comprising 35% of construction cost, which are up 16% and 9%, respectively, since October 2010. What makes life difficult for developers is that sales are down in four of the top six markets—Mumbai Metropolitan Region, National Capital Region, Pune, Hyderabad—as prices went up in some markets in FY11 by up to 30%. With an all-time high inventory of unsold stock (around 500 million sq ft) that could take another 22 months (around two years) to clear, higher rates will not only impact end-user demand but also squeeze developers through higher interest expense. “If buyer sentiment takes a knock it can halt the growth that the industry has seen post-the global crisis,” warns Credai’s Jain. Also feeling the heat is another rate sensitive sector—automobiles. Says Rajeev Kapoor, president and CEO of Fiat India: “Higher rates will result in lower walk-in and conversion.” That would be a sea-change for a sector that had seen roaring growth last fiscal. Automobile sales had surged over 30% in FY11, driven by 24 new launches and relatively benign auto loan rates. Going ahead, the Society of Indian Automobile Manufacturers (SIAM) expects sales growth to slow down to 12-15% in the current fiscal, due to the high base of last year and rising interest rates. “The industry has been absorbing the increase in input costs for a long time, but going ahead car makers will be forced to pass on the burden to the customers as their profit margins are already under pressure,” said Pawan Goenka, President, Siam, in a statement. Within the consumption pack, unlike the auto industry, FMCG players are least impacted by the rate hike, but are bearing the brunt of higher commodity prices. Marico Industries, makers of Parachute and Saffola, has seen a close to 20-25% hike in raw materials costs, which has forced the company to hike prices of its products by around 10-12%. “Increase in prices has obviously led to shrinkage in margins and growth rate,” admits Saugata Gupta, CEO, consumer division.
No Way Out
Given the adverse turn of events and looming macro concerns, foreign institutional investors have already pressed the panic button by dumping Indian stocks worth over Rs 3,000 crore in the first week of May after pumping in over Rs 7,000 crore in April. What is cause for concern is that though headline inflation could cool off following the recent selloff in crude oil and other commodities globally, food inflation will continue to stay high. In fact, Subbarao has on several occasions raised the point of addressing the supply-side bottlenecks. “RBI is responsible for management of inflation. But responsibility for food inflation is slightly lower because food inflation arises due to supply-side constraints,” he said in a statement. Since that cannot be addressed right away, monetary tightening could be further resorted to contain inflation in the manufacturing sector. In other words, the repo rate could rise from the current 7.25% to the FY08 levels of 9%. Economists such as Chetan Ahya of Morgan Stanley and Shubhada Rao of Yes Bank expect rates to rise 75-100 basis points during the course of the year. That could well mean that India Inc’s nightmare will not end anytime soon.
Outlook
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