Factory output at 22-month high; RBI may not hike rate5 min read . Updated: 13 Oct 2009, 12:20 AM IST
Factory output at 22-month high; RBI may not hike rate
Factory output at 22-month high; RBI may not hike rate
Mumbai: India’s factory output grew at its fastest pace in 22 months in August, signalling the country’s recovery from the slowdown and giving its central bank scope to raise interest rates, but economists say the Reserve Bank of India (RBI) could maintain status quo in its October policy as the sustainability of the recovery remains doubtful—for now.
Output at factories, utilities and mines rose 10.4% in August from a year earlier, higher than what economists expected, and July’s annual growth was revised up to 7.2% from 6.8%.
A lower interest rate regime has helped companies access funds at a cheaper rate and various sops and incentives extended by the government to the industrial sector have helped them expand their operations.
As part of its accommodative monetary policy regime, the central bank brought down its policy rate from 9% to 3.25% between October 2008 and April 2009 and pared the portion of deposits that banks are required to keep with it from 9% to 5%.?The government reduced taxes on consumer products and imports too and together the banking regulator and the government offered a stimulus worth at least 12% of India’s Rs56 trillion gross domestic product to lift a sagging economy.
Listen to Rupa Regi Nitsure, chief economist at the Bank of Baroda, talk about the IIP data
According to D.K. Joshi, principal economist of rating agency Crisil Ltd, the industrial growth number cannot be interpreted as a sure sign of recovery as yet.?“We have to evaluate some factors: What is the overall demand in the economy and what is the private demand? The healthy numbers we are seeing are mainly because of the government initiatives but an economic recovery cannot happen unless private demand is robust."
Sougata Bhattacharya, chief economist of Axis Bank Ltd, said a lot of growth momentum has been driven by pre-festive season sales of consumer durables. Sales of products such as television sets, washing machines and refrigerators surged by an annualized 22.3% as stimulus measures helped fuel demand. “We are getting stronger signs of recovery but will it sustain in the next four-five months? A call on whether recovery is secured can be concluded if the post-October numbers remain steady," Bhattacharya said.
Other economists echoed that sentiment of caution.
“The numbers are quite skewed and not broad-based. There is a healthy growth in mining and consumer durables but capital goods and non-consumer durables have not picked up really," said Rupa Rege Nitsure, chief economist at Bank of Baroda.
In this context, RBI may not raise banks’ cash reserve ratio or the interest rate when it announces the six-month review of monetary policy on 27 October. “Even if RBI increases the policy rate, banks will not be able to increase their lending rates because even with this low interest rates banks are struggling to find borrowers," said Nitsure.
Credit growth in the banking industry has dropped to 12.6% compared with 25.2% last year and around 30% for several years before that.
According to economists, the most critical factors that RBI will consider in its October policy will be inflation and the government’s massive borrowing programme.
“Something has to be done and will be done, but there is a high probability that RBI may maintain a status quo and go for monetary tightening subsequently, may be even before the next policy," said A. Prasanna, chief economist of ICICI Securities Primary Dealership Ltd that buys and sells government bonds. “The biggest challenge before RBI at this moment is the massive borrowing programme of the government and this will remain in the next year too," he said.
The government plans to borrow a record Rs4.51 trillion this year to bridge a 6.8% fiscal deficit.
The inflation rate turned positive in early September and is expected to cross 5% by March. An increase in interest rate helps curb inflation as money becomes costlier but it dents the growth momentum.
“A rate hike, or withdrawal of liquidity at this point, would be pre-emptive which RBI may not want to do unless it is sure about overall economic growth," said Joshi of Crisil, adding that the private consumption growth, according to Central Statistical Organisation data, is only 1.6% now compared with a normal 8%.
Rajeev Malik, head, India and Asean economies, Macquarie Securities, said a rate hike is highly unlikely, but added that he wouldn’t rule out an increase in the cash reserve ratio as an effort to tighten liquidity.
He cautioned that the ongoing economic recovery is still in early stages. “Any premature tightening would sap the strength of recovery. Also, we believe that tightening monetary policy at this juncture won’t affect inflation expectations as it would not fix the problem of higher food prices, but could have the unintended consequence of negatively affecting the growth momentum."
Robert Prior-Wandesforde, senior Asian economist of The Hongkong and Shanghai Banking Corp. Ltd, expects the first cash reserve ratio hike to come in early 2010, with policy interest rates increasing from the April to June quarter next year.
Pranjul Bhandari and Tushar Poddar of Goldman Sachs Global ECS Asia Research, in a report released on Monday, said: “With growth and inflation expected to be higher, we now expect 300 basis points of tightening in policy rates in calendar year 2010 starting in January. In addition, we expect higher inflation to allow the RBI to be more tolerant of rupee appreciation." One basis point is one-hundredth of a percentage point.
Kevin Grice, an economist at Capital Economics Ltd in London, seems to be the most bullish among economists on prospects of a rate hike. With doubts over the durability of India’s upswing fading all the time, and inflation pressures already high, policy rates look certain to move up soon, said Grice. “We still expect a first hike in January, but the possibility of a first move at the October 27 monetary policy meeting now looks close to a 50:50 call."
Kartik Goyal of Bloomberg and Rajkumar Ray and Manoj Kumar of Reuters contributed to this story.