It’s now fairly certain that growth in the world’s 10th-largest economy is slowing even though the pace of deceleration is not alarming. In its first mid-quarter monetary policy review, India’s central bank has said that signs of growth moderation are visible in some sectors, but broad indicators of economic activities such as fourth quarter earnings of Indian corporations and loan growth in the banking industry do not suggest any sharp slowdown.
Year-on-year credit growth till 3 June has been 20.9%, higher than the Reserve Bank of India (RBI) projection. Earnings of listed Indian companies in the March quarter grew at the slowest pace in three quarters as rising input costs eroded profit margins, but sales remained buoyant, riding on higher prices. Profit at 27 of the 30 companies that constitute the bellwether equity index, the Sensex grew 4.4% in the March quarter over the year-ago period, after expanding at an average 12% in the previous three quarters. Sales growth, however, was higher at 20% for these companies, in line with the previous three quarters.
RBI has not seen any dent in demand and pricing power of corporations despite the sharp increase in input costs—an argument challenged by most industrial lobby groups.
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Factory output in April, based on a revised index with fiscal 2005 as the base year, moderated to 6.3%—lower than 7.8% in March. Based on the old series, the Index of Industrial Production (IIP) grew in April at 4.4% year-on-year (y-o-y) versus 8.8% in March, a clear indication that growth is moderating. Economic growth in the March quarter was also lower than expected—7.8% y-o-y, down from an upwardly revised 8.3% in the December quarter. This was much below the consensus estimates of 8.1% by analysts, and the lowest since December 2009.
The HSBC Purchasing Managers’ Index (PMI) for manufacturing too confirms the moderation in India’s economic growth. PMI was at 57.5 for May, slower than the pace of growth seen in the preceding three months. The PMI numbers are indicative of seasonally adjusted month-on-month increases.
More than 50 indicates expansion, and less than that signals contraction. The 57.5 reading for May indicates that the Indian economy is slowing, but one should not read too much into it as the rate of growth continues to be strong.
Which is why RBI went ahead with yet another rate hike, its 10th since March 2010. With the latest hike—25 basis points (bps) after a 50 bps hike in May—India’s policy rate is now 7.5%, 425 bps higher than what it was in March 2010. One basis point is one-hundredth of a percentage point. RBI, in fact, started its rate tightening cycle to fight rising inflation in January 2010 with the hike in banks’ cash reserve ratio (CRR) or the portion of deposits that they need to keep with the central bank. CRR was raised from 5% to 6% between January and March 2010.
In its annual policy, RBI went all out to tame inflation even though it was well aware that aggressive rate tightening would dampen growth in the short run. It did so as persistently high inflation affects long-term growth. The average wholesale price inflation in India was close to 9.5% last year, much higher than RBI’s twice-revised inflation projection.
While inflation continues to remain high, its profile has changed—from food inflation it has spilled over to other areas and become broad-based. More importantly, the non-food manufacturing inflation, a proxy for core inflation, hit a high of 8.5% in March. It was 6.3% in April and 7.3% in May, but both are provisional figures and final figures could be around 8% or more.
Indeed, RBI continued with its anti-inflationary stance in its June review, but there was a subtle change in the language of the policy as global risks to growth have dramatically risen in the past few weeks with the sovereign debt crisis in Europe and disappointing US economic data. Commodity prices too have softened to some extent.
The latest oil price hike will have an impact on inflation, which is expected to remain high for the next few months and probably more than RBI’s projection of 9% till September. But with signs of a slowdown getting more pronounced, RBI is probably coming close to the end of its rate-tightening cycle. One can expect another 25 bps hike before the Indian central bank reaches the neutral zone.
The cost of money in the system, however, will continue to remain high and banks will pass on the high cost to borrowers as the impact of RBI’s earlier hikes has not fully played out yet. Higher borrowing costs will definitely influence investment decisions of corporations that have been going slow on their expansion plans for other reasons as well. All this means that the economic slowdown will gather pace in India, albeit gradually.
Typically, bank credit grows at between two and three times the growth in India’s gross domestic product or GDP. In fiscal 2006, bank credit expanded at 30.8%while GDP grew at 9.5%. In 2007, the comparable figures were 28.14% and 9.6% and in 2008, 22.3% and 9.3%.
GDP growth dropped to 6.8% and credit growth to 17.51% in 2009 owing to the global financial meltdown in the wake of the collapse of US investment bank Lehman Brothers Holdings Inc. The next year, GDP grew at 8%, but credit growth was down to 16.91% as a few banks were still reeling under the impact of the global crisis and shrinking their assets. In the last fiscal, bank credit grew at 21.4%, faster than RBI’s estimate, while the economy grew at 8.5%.
Indian corporations may find it difficult this year to access money from banks as the government is expected to borrow more than the targeted Rs 4.5 trillion with the fiscal deficit likely to widen beyond the budget estimate.
But there is unlikely to be a severe credit crunch; most large companies are resilient, have strong balance sheets and can tap other sources of money. Growth will probably be 8% or less, but is unlikely to slow to an embarrassing level.
And let’s accept the fact that the Indian economy can never grow at double digits unless the government pushes hard for further economic reforms and addresses structural issues. It’s unfair to expect monetary policy alone to carry the burden of fighting inflation and ensuring growth.