If the world’s largest economy is about to slip into a recession, isn’t it time our policymakers bought some insurance for the domestic economy?
Now that the US Federal Reserve has cut interest rates a total of 175 basis points since September, shouldn’t the Reserve Bank of India (RBI) follow suit?
Wholesale price inflation is at 3.79% year-on-year, well below RBI’s 5% target. And 3.7% is also the rate of increase in the wholesale price index for manufactured products. The fuel index is also up 3.7%, while the primary products index has risen by 4.1%. Within primary products, the index of food articles is up just 2.7% and the main increase has come from the rise in the prices of fibres, which have gone up 22.2%. Raw cotton prices, for example, have risen 24.5%. So the concern about rising food prices may have been overdone. As for the manufactured products index, RBI should look ahead—rising capacity on the one hand and a global slowdown on the other is a sure signal of lower prices. The slowdown will also impact commodity prices and crude oil has already slipped considerably. Future inflation, therefore, is likely to be moderate.
There are also signs of domestic deceleration. The index of industrial production has been trending lower, bank credit growth has slipped from more than 30% to 21.5% year-on-year, export growth has slowed and the stock market crash could affect companies’ ability to raise funds for expansion. Our real interest rates are way above the average for the region and for the world.
The other reason for cutting rates is the increasing differential between rupee and dollar interest rates. This would, points out ICICI Securities Ltd’s economist A. Prasanna, put upward pressure on the rupee unless RBI acts to reduce the differential. The 10-year government bond yield has come down from almost 8.5% last year to less than 7.5%, without RBI reducing rates. That’s because of the lower inflation numbers on the one hand and the market’s increasing certainty that interest rates are headed down, on the other. As Prasanna emphasizes, the bond market has already priced in at least a 25-basis-point rate cut. For all these reasons, the time for RBI to cut rates is now.
Grasim Industries Ltd reported a 23.6% growth in consolidated operating profit for the December quarter— much lower than the 38.8% it managed in the first two quarters of this fiscal. But analysts tracking the company wouldn’t be particularly disappointed. The cement division, which accounts for two-thirds of consolidated revenues and profit, was expected to have a muted quarter. The segment’s profit grew 16% on a consolidated basis—down from 28.4% in the first two quarters. Profit growth was restricted because of capacity constraints on the one hand and higher fuel and freight costs on the other. This more than offset the better price realizations the company enjoyed during the period.
On the positive side, the viscose staple fibre (VSF) business continued to set records in terms of profit. The segment reported its highest ever profit and margin of more than 41%. Demand for VSF is strong both in the domestic and international markets, because of which average realizations are 21% higher year-on-year. Price realizations have also been higher because the cost of global pulp has soared, which has been passed on to customers. In Grasim’s case, it has an added benefit since the sharp rupee appreciation has lowered the cost of its pulp purchases.
The company has planned a brownfield expansion through which its capacity will increase by about 35%. Another greenfield plant, which will be commissioned in two-three years’ time, will add an additional 24% to capacity. According to Grasim, there is a resistance at current price levels, and margins are likely to see some decline owing to cost pressures. Even so, the expected increase in volumes will add materially to profit.
The high contribution from the cement segment, however, has weighed on the Grasim stock, which has underperformed the market in the past year. In the recent correction, the stock has fallen about 22% from its highs, and now trades at close to 10 times consolidated earnings.
But with cement prices expected to peak by the end of fiscal 2009, and the regulatory risk involved in the sector, returns may not be spectacular going forward.
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