Car sales are considered lead indicators in many economies. They give advance signals about what lies ahead. So, the news that car sales actually dropped in April and May, for the first time in three years, should not be taken lightly. The sector has strong linkages to many other parts of the economy— from steel to tyres to forgings. The question is: will lower car sales eventually pull down sales in these sectors too?
The slowdown is far from apparent if one looks at the aggregate numbers. Data for the latest month, captured in the index of industrial production, pegs industrial growth at 13.6% in April. But a sector-wise look at the data shows some interesting trends. There has been a double-digit surge in production of capital goods (17.7%), intermediates such as steel (12.6%) and consumer non-durables such as cosmetics and services (21.9%). However, growth in production of consumer durables such as automobiles and television sets, which are directly affected by the rising cost of credit, rose by 5.3% after averaging 9.1% in 2006-07.
Two things stand out. One, the current phase of growth is investment-led. Hence, given the multiplier effects of such investments, it is clear that the growth momentum in the economy will be sustained in the medium term. Second, the automobile manufacturers are right in their perception that deceleration in consumer durables is a fact of life.
These trends may in fact be the key to anticipate the next step the Reserve Bank of India (RBI) is likely to take. It has, after all, over the past year carried out five interest rate hikes and twice increased banks’ cash reserve requirement to curb inflation. The result: lending rates have on an average gone up by 300 basis points, growth in bank credit has slowed to 26% and inflation, as measured by the wholesale price index, has dropped below 5%.
What this seemingly satisfactory macroeconomic report card does not reveal is that the ongoing credit tightening does not hurt every sector equally. That explains why the economy continues to see robust growth despite a sharp hike in borrowing costs.
The logic is rather simple. Investment demand is being financed mostly by domestic issues of equity or by raising external commercial borrowings. Demand for consumer durables, on the other hand, is being fuelled by consumer credit extended by banks.
Clearly, liquidity curbs are not impacting investment demand while they have, as the industrial production data shows, begun to kick in with respect to consumer durables. So, RBI is partially succeeding in its objectives. To put it another way, further tightening of liquidity will squeeze growth in consumer durables demand even more. It is unlikely to impact investment demand, unless insipid sales of cars, television sets and the like force companies making these goodies to hold back their investment plans. In short, the threat to investment is more long-term rather than immediate.
Which brings us to the runaway growth in consumer non-durables—a segment normally associated with lifestyle, and also a proxy used to measure consumer confidence. The numbers here continue to be impressive, though they have been exaggerated by a 50%-plus growth in the output of food products.
In the net, therefore, it is clear that the credit squeeze has not impaired the growth trajectory of the economy, though it has begun to take its toll in select sectors. With the inflation rate abating, it is probably a good time for RBI to start thinking of easing its monetary policy.
Not immediately perhaps, since the drop in inflation is a recent event and it will be worth ensuring that it is no flash in the pan. But lower inflation and the first signs of slowdown in some types of consumer spending show that interest rate hikes are working.
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