Has the Reserve Bank of India (RBI) hike in policy rates, together with the fall in inflation, resulted in higher real interest rates? Real interest rates are nominal interest rates less expected inflation. Given the difficulties of measuring expected inflation, however, a rough and ready method of computing real interest rates is to take the current rate less inflation. By that measure, the real rate in India is still very low in the list.
As the table shows, the only other country with negative real interest rates is China, which raises the question whether it is low real interest rates that have been responsible for the phenomenal growth rates notched up by the two countries.
What’s more, several central banks in countries where real interest rates are much higher than in India are likely to raise rates further. These include the UK, the European Union, Taiwan and South Korea. The Bank of Japan, too, is widely expected to raise its policy rate in August.
Does this mean that RBI should raise interest rates again? Well, it could be argued that if the repo rate (a key lending rate), which is 7.75%, is taken instead of the three-month T-bill rate, the real interest rate is much higher, although even then it would be lower than in most countries. Or, it could be argued that the CPI (consumer price index) will soon come down, following the wholesale price index, so inflationary expectations are actually lower than the current inflation rate. Or, we could look at bank lending rates, which are much higher.
The reason for the low real rate, of course, is the liquidity flooding into the country. And while it may not have raised the prices of goods and services, it certainly has led to asset price inflation. Few people will have a problem with that.
Cement stocks are back in favour—the market cap of the top 10 listed cement firms has risen by 24% in less than a month, easily beating the Nifty’s return of 5% in the same period. Before the recent surge, these shares had lost about 30%, primarily over fears of a freeze on prices by the government.
What led to the improvement in sentiment was a categorical denial by the finance minister in a recent television interview that there was no freeze on prices.
Cement manufacturers followed this up with a token hike in prices in the northern and western regions. (Prices were being raised in the South regardless of the freeze). But even after the current rise in share prices, the combined value of the top 10 firms is about 12.5% lower than the peak reached in January this year. This is because the street is still divided on how soon supply will overtake demand.
Some are of the view that capacity expansion plans by various players and the prospect of cement imports will lead to an excess supply situation in areas such as North India as soon as March 2008. This view puts to rest any hope that bumper profits would continue for another two years, resulting in cement stocks looking overvalued at about 15 times inflated earnings near the peak of the cycle.
But more recent research shows that greenfield projects planned by cement manufacturers are getting delayed. Analysts say that most of the plants that are expected to add substantially to capacity will be fully operational only in the second half of financial year 2008-09. Beyond that, an oversupply situation would adversely affect the northern region (about 20% of the total market).
Things are expected to get worse in the southern market as well. But on an all-India basis, the mismatch in demand and supply is expected to continue beyond fiscal 2009. What’s more, things remain upbeat on the demand front—analysts are assuming growth of at least 10% per annum in the medium-term. In sum, it does look like the good times are here to stay for the cement industry.
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