Industry's first quarter growth is closely linked to the full year's growth - in which case, write off this year.
With higher interest rates putting pressure on both the demand and supply sides, there is a lot of concern about whether industrial growth will pick up. On the demand side, fewer goods are demanded that depend on credit such as automobiles, consumer durable goods, and housing. This in turn affects the output of these industries, causing them to cut back on investment which slows down overall growth. On the supply side, higher interest rates make borrowing expensive and companies defer investment plans. Holding costs of inventory increase and affect the bottom lines of companies.
The most recent number for industrial growth has been put at 5.2 per cent for the first quarter of the year. What is one to make of it? Relative to last year, this number is quite low as it was 10.3 per cent last year. The high base year effect is a plausible explanation, though there is still considerable scepticism about this. Does this mean that growth will be low by the end of the year? At a theoretical level, the period up to August or so is considered to be the slack season because typically one would not be spending too much on consumption goods during this period. Normally, people spend more during the festival season that starts from August onwards. We have Raksha Bandhan, Janmashthami, Ganesh Chathurthi (in the west), Dassera, Diwali, Christmas, and New Year that are associated with festival spending. This happens all across the country where people invest in a variety of things, right from clothing for the family to dwellings. The idea being that purchasing is associated with an auspicious occasion.
As we move to rural areas, the harvest factor also plays a role. Typically the kharif harvest begins in October or so and goes on through till December. It begins again in the months of April and goes on till May when the rabi harvest begins. Therefore, spending again increases from the Baisakhi-Holi time, albeit at a slower rate since festival season is over. Against this background, the argument goes, one should not be startled at a lower industrial growth rate in the first quarter of the year as this is how it should be.
This was the school of thought for a long time when the RBI also called its credit policy the slack season policy from April to October and the subsequent period was called the busy season. In fact, in the past, there was a tendency for the RBI to try and complete 60-70 per cent of the government’s borrowing programme in the first half of the year when there was less demand from the commercial sector. However, in the last decade or so, the RBI has given up differentiating between the two seasons as the tendency for spending has evened out through the year. Therefore, demand for credit today is considered to be an element that needs to be monitored throughout the year and hence deserves attention. It is not surprising that the RBI has resorted to monetary action at any time of the year unlike in the past when the second half mattered more.
In fact, it is often said that the quickest way to gauge economic confidence levels in the country is to count the number of “sales” that are going on around in the country. Usually, as stated earlier, these discount sales are meant for the festival season where dealers compete to garner a greater share of the consumers’ wallet. However, this year, the competitive discount season has begun earlier for all the consumer goods segments. This holds for automobiles and housing projects too where the spectre of higher interest rates in the future is being used to attract customers to get into deals immediately. Independence Day has now become a landmark day for potential customers!
In this context it would be useful to see how annual growth in industrial output has behaved relative to the growth in the first quarter. More importantly, is it possible to conjecture the extent of overall growth based on the information of first quarter?
As can be seen from the table, there is very strong correlation between the growth rate witnessed in the first quarter of a year and the growth for the entire year (around 85 per cent). Low growth in the first quarter invariably translates into a low growth for the entire year, while a high growth rate may not necessarily do so. Hence, looking at a growth rate of 5.2 per cent in the first quarter, based on past experience, it may be conjectured that industrial growth for the entire year would be at best between 6.5 per cent and 7 per cent.
Coincidentally, the projections of the Economic Advisory Committee of the PMO (EAC) had scaled down GDP growth projection for the year to 7.7 per cent and that of industry to 7.5 per cent. This could be attributed to both the high interest rate regime as well as the high base year effect where industrial growth has been greater than 8 per cent for four successive years while peaking at 11.5 per cent in FY07.
In which case, we need to revisit the calculations for GDP growth this year, where the monsoon will be critical as agriculture will play a decisive role in determining the final figure. With a 7 per cent growth rate and a 20 per cent share in GDP, industry will contribute a maximum of 1.4 per cent to GDP growth, while agriculture with a share of 17 per cent will need to clock 4 per cent to add another 0.7 per cent. We would still be need services to grow by 9 per cent to end up with a final number of 7.8 per cent. Can this be done?
Thursday, August 28, 2008
Tuesday, August 26, 2008
After the Godzilla Effect: Financial Express: 26th August 2008
Banking was a rather somnolent business until 1992 when bankers simply waited for the customers to walk up to them, because the latter didn’t really have many choices. Then the force of competition ushered in by the implementation of the Narasimham Committee Report changed this landscape substantially. The entry of new private banks and the spread of foreign banks added momentum to these changes. But the strategies that initially took innovative routes have ironically returned to a pre-reforms mode typified by conservatism. Consider the following u-turns:
New private banks have usually been innovative trendsetters. They were the first ones to introduce technologies like ATMs and phone banking and Internet banking, which were swiftly accepted by their customers. Till a short time ago, there was immense competition among these banks to grab ATM leadership. First, ICICI Bank claimed this spot, but SBI soon let it be known that it was the one with the highest number of ATMs in the country. But now the RBI is encouraging banks to share their ATMs to save on equipment costs, and the numbers game has become non-existent.
Secondly, in the initial post-reforms phase, banks were keen to attract customers by giving out bundled products such as cards, loans etc. The idea was to reach out to as many customers as possible and garner market share. The move was towards mass banking. Today, however, banks want only high-end customers and have changed tracks.
On the lending side, banks initially went in for big-ticket customers as the Godzilla effect took shape. Corporates were segregated into large and small categories, with the focus being on the larger ones that were expected to help maintain better quality portfolios. While the private banks took the lead here, the public sector banks also followed the same route to keep in the race. Today banks have switched over to the SME route on the grounds that this is category with the larger potential, and also has a healthy track record.
There was also a time when banks were rushing into the retail segment. The idea was that housing loans were safe bets with low default rates. Besides, as houses were hypothecated to banks, there was reason to believe that these loans could not go bad. Banks hence lent extensively to this sector and set up special divisions for the same. Low interest rates and longer tenures were the attractionsHowever, with interest rates climbing of late and the shadows of the sub-prime crisis hanging over us, banks are fast withdrawing from this segment. They are increasing rates to better protect their bottom lines, and trying to ensure better repayments by focussing on high-end customers.
Earlier, banks were offering variable lending schemes where borrowers had the choice of fixed and flexible interest rates. This was at a time when the flexible schemes made sense because rates were poised southwards. With interest rates going up lately, these options are hardly exercised anymore, and we are seeing only fixed rates in both the deposits and loans segments.
Also, in the post-reform period, the basic mantra for expansion has been one of taking over smaller banks in order to reap economies of scale: one got branches, customers, business and skilled staff through such mergers. Today the sector is wary of mergers, especially since there is now the possibility of foreign banks actually taking over Indian banks after 2009, when this sector is opened up.
These u-turns mean that the current landscape is characterised by well-diversified conventional portfolios and stable rates rather than variable rates. On the deposits side, customers are returning to the branches even though other modes have been remarkably well accepted. While mass banking is still the preferred choice today, class banking is increasingly being prioritised. In short, the overall approach to strategy appears to have come full circle, or almost.
New private banks have usually been innovative trendsetters. They were the first ones to introduce technologies like ATMs and phone banking and Internet banking, which were swiftly accepted by their customers. Till a short time ago, there was immense competition among these banks to grab ATM leadership. First, ICICI Bank claimed this spot, but SBI soon let it be known that it was the one with the highest number of ATMs in the country. But now the RBI is encouraging banks to share their ATMs to save on equipment costs, and the numbers game has become non-existent.
Secondly, in the initial post-reforms phase, banks were keen to attract customers by giving out bundled products such as cards, loans etc. The idea was to reach out to as many customers as possible and garner market share. The move was towards mass banking. Today, however, banks want only high-end customers and have changed tracks.
On the lending side, banks initially went in for big-ticket customers as the Godzilla effect took shape. Corporates were segregated into large and small categories, with the focus being on the larger ones that were expected to help maintain better quality portfolios. While the private banks took the lead here, the public sector banks also followed the same route to keep in the race. Today banks have switched over to the SME route on the grounds that this is category with the larger potential, and also has a healthy track record.
There was also a time when banks were rushing into the retail segment. The idea was that housing loans were safe bets with low default rates. Besides, as houses were hypothecated to banks, there was reason to believe that these loans could not go bad. Banks hence lent extensively to this sector and set up special divisions for the same. Low interest rates and longer tenures were the attractionsHowever, with interest rates climbing of late and the shadows of the sub-prime crisis hanging over us, banks are fast withdrawing from this segment. They are increasing rates to better protect their bottom lines, and trying to ensure better repayments by focussing on high-end customers.
Earlier, banks were offering variable lending schemes where borrowers had the choice of fixed and flexible interest rates. This was at a time when the flexible schemes made sense because rates were poised southwards. With interest rates going up lately, these options are hardly exercised anymore, and we are seeing only fixed rates in both the deposits and loans segments.
Also, in the post-reform period, the basic mantra for expansion has been one of taking over smaller banks in order to reap economies of scale: one got branches, customers, business and skilled staff through such mergers. Today the sector is wary of mergers, especially since there is now the possibility of foreign banks actually taking over Indian banks after 2009, when this sector is opened up.
These u-turns mean that the current landscape is characterised by well-diversified conventional portfolios and stable rates rather than variable rates. On the deposits side, customers are returning to the branches even though other modes have been remarkably well accepted. While mass banking is still the preferred choice today, class banking is increasingly being prioritised. In short, the overall approach to strategy appears to have come full circle, or almost.
Tuesday, August 12, 2008
Cracks in the Communist Citadel: 12th August 2008
The Chinese citadel appears to have finally developed some cracks. China is now a country that is looked at with a growing degree of suspicion. Curiously, the reasons are both political and economic, with the most recent trigger for dissatisfaction being Tibet. In fact, even the Olympics preparations were marred by tales of distress caused to the local population by the government to placate its own ego. Add to this the sympathies with rogue regimes in Sudan, Myanmar and North Korea, the scales get tipped even further.
With China’s progress now coming under the lens, there are some interesting facts which have been brought to the forefront. First, while Chinese economic numbers have always been suspicious, the theory now doing the rounds is that GDP growth numbers are overstated. This is so because they are collected from the provinces which have a tendency to over-report to be on the right side of the government. Further, growth in industrial production or services does not match with the overall growth numbers of the economy. The relevant question is, where is growth coming from?
Second, inflation numbers that have been quoted at low levels are being attributed to repression in areas of health, transport, education as they are state governed, which tends to understate the true picture. Food prices, too, are partly controlled and hence the country is buffered against the present inflation which has swept almost all nations.
Third, China is supposed to have started a new kind of colonialism wherein it consumes the bulk of natural resources available in the world. China accounts for half of the pork consumed, a third of steel produced, nearly 80% of the copper used, a quarter of aluminium consumed and half of total cereals produced in the world. Its consumption of imported soybean and crude oil has increased by 35 times since 1999. This was what colonialism was all about: in the 19th century it was through conquests, while it is legitimately done through the channel of foreign trade today.
The quality of the growth story does not look good as it involves the running of sweatshops where labour is virtually bonded to produce cheap goods while being kept at a subsistence level. Hence, the manner in which price competitiveness has been achieved would not be politically correct in a free society. Fifth, the quality of goods produced is not always world-class as has been seen in case... of electronics or even toys, where it was found that Chinese toys contain toxic substances. Sixth, China is one of the largest polluters in the world as its quest for industrial growth has led to the degradation of the air as well as water. Curiously, the power consumed in the steel industry is higher than what goes into households, and this has resulted in such degradation.
There are also other economic distortions that have resulted from the process of rapid growth, which will impact its own functioning, notwithstanding controls being exercised by the state. The first is, unbalanced growth in favour of industry which has lowered the quantity of arable land. Land was forcibly used for industrialisation as a result of which there is less space available for cultivation and greater demand for imports. At the same time, China has put restrictions at times on exports, thus tilting the global price scales. The demand for farm products, energy and minerals has pushed up global prices at a time when the world is struggling with a financial crisis and central banks are grappling with their monetary policies. Add to this the policy of not appreciating the currency and artificially pushing down the interest rates—-China has in fact encouraged indiscriminate lending by state-run banks, which have officially reported non-performing loans in the region of 5-10%, though analysts suspect it could be over 20%.
What then is one to make of the whole story? China remains a leader despite the political dogma which still is a hard nut to crack. Considering that future growth will still be driven from this side of the world, there is a need for introspection by the government about cleaning up the mess which is being created along the way as it is bound to rebound perversely at some point of time.
With China’s progress now coming under the lens, there are some interesting facts which have been brought to the forefront. First, while Chinese economic numbers have always been suspicious, the theory now doing the rounds is that GDP growth numbers are overstated. This is so because they are collected from the provinces which have a tendency to over-report to be on the right side of the government. Further, growth in industrial production or services does not match with the overall growth numbers of the economy. The relevant question is, where is growth coming from?
Second, inflation numbers that have been quoted at low levels are being attributed to repression in areas of health, transport, education as they are state governed, which tends to understate the true picture. Food prices, too, are partly controlled and hence the country is buffered against the present inflation which has swept almost all nations.
Third, China is supposed to have started a new kind of colonialism wherein it consumes the bulk of natural resources available in the world. China accounts for half of the pork consumed, a third of steel produced, nearly 80% of the copper used, a quarter of aluminium consumed and half of total cereals produced in the world. Its consumption of imported soybean and crude oil has increased by 35 times since 1999. This was what colonialism was all about: in the 19th century it was through conquests, while it is legitimately done through the channel of foreign trade today.
The quality of the growth story does not look good as it involves the running of sweatshops where labour is virtually bonded to produce cheap goods while being kept at a subsistence level. Hence, the manner in which price competitiveness has been achieved would not be politically correct in a free society. Fifth, the quality of goods produced is not always world-class as has been seen in case... of electronics or even toys, where it was found that Chinese toys contain toxic substances. Sixth, China is one of the largest polluters in the world as its quest for industrial growth has led to the degradation of the air as well as water. Curiously, the power consumed in the steel industry is higher than what goes into households, and this has resulted in such degradation.
There are also other economic distortions that have resulted from the process of rapid growth, which will impact its own functioning, notwithstanding controls being exercised by the state. The first is, unbalanced growth in favour of industry which has lowered the quantity of arable land. Land was forcibly used for industrialisation as a result of which there is less space available for cultivation and greater demand for imports. At the same time, China has put restrictions at times on exports, thus tilting the global price scales. The demand for farm products, energy and minerals has pushed up global prices at a time when the world is struggling with a financial crisis and central banks are grappling with their monetary policies. Add to this the policy of not appreciating the currency and artificially pushing down the interest rates—-China has in fact encouraged indiscriminate lending by state-run banks, which have officially reported non-performing loans in the region of 5-10%, though analysts suspect it could be over 20%.
What then is one to make of the whole story? China remains a leader despite the political dogma which still is a hard nut to crack. Considering that future growth will still be driven from this side of the world, there is a need for introspection by the government about cleaning up the mess which is being created along the way as it is bound to rebound perversely at some point of time.
Monday, August 4, 2008
Pains and Gains of Credit policy: Financial Express: 4th August 2008
This was one of the rare occasions when everybody got it wrong. Most economists and treasurers expected no change in the policy, while some of the more aggressive ones pitched for a repo rate hike. But, the RBI, which has developed a knack of surprising markets, which is what the Rational Expectations School would have supported, did the unexpected i.e. raising both the repo rate and the CRR. The markets, naturally were taken aback.
Taking any policy decision on the 29th was going to be a tough decision considering that the RBI had to really toss for either inflation or growth. Growth appears to be a downward path and inflation well entrenched at a double-digit mark. As neither lower growth nor high inflation are acceptable, especially since the next general elections will hopefully be held against the backdrop of these two numbers, the rational belief was that RBI would do nothing to hurt growth, while inflation would be guided by past policy decisions as well as improvement in real sector supplies.
By opting to increase the CRR and repo rate, RBI has made it clear that it is antagonistic towards inflation. Further, by talking of a rate of 7% towards the end of the year, it does hope that these measures work.
There are two parts to this story, which is the case with all monetary policies. One needs to closely look at both inflation and growth.
Inflation today is a cost-side driven phenomenon and therefore cannot be directly affected by monetary policy. If there are shortfalls in foodgrains production or oilseeds output, no amount of monetary tightening will help. Money supply growth is increasing but the growth in credit is more due to the higher lending to the oil companies rather than an industrial revival. In fact, as discussed later, industrial growth has slowed down. Such lending will carry on nonetheless as it has to be done.
There can be two explanations behind raising interest rates to control inflation. The first is that inflation has now reached a stage where there are negative real interest rates. With inflation ruling at 12% a deposit holder with an interest rate of 10% is actually still in the negative territory by 2%. But, by raising the interest rates by 50 bps we are only narrowing the gap and not eliminating the same. In fact, if this is going to be a policy decision, then there are hard times signalled for the future. The second reason could be that RBI would like to stifle inflationary expectations such that overall spending through borrowing is curbed, which will moderate the build-up of demand-pull forces. The thought process here is that inflation as such is not as dangerous as inflationary expectations. If all expect inflation to go up, and then inflation will move up - a self-fulfilling prophecy. By raising rates now, people will automatically spend less, thus either reducing demand or deferring the same, both of which will lead to lower inflation. This is the approach the European Central Bank has also taken when increasing its benchmark rate a while ago.
However, what is interesting here is that since March 31, 2008, RBI has increased the CRR by 125 bps and the repo rate by 75 bps (before this policy). But, inflation has not really come down and remains in the double-digit level. While it is not clear as to the exact time taken for these measures to bear fruition, it is felt that the period would vary between 2-4 months. Therefore, if these rate hikes have to work, they should be doing so now.
The second part of the story is growth, and industrial advance has been tardy during the first two months of the year, and the symptoms are not too encouraging. There are no real signs of large investment taking place. Overall corporate performance appears to have slowed down this year and the increasing interest rate regime is part of this story. By raising rates further, there is a possibility of the slowdown becoming more acute.
High interest rates affect the industry on both the demand and supply sides. On the supply side higher rates increases costs for companies, which may prompt them to defer investment plans, especially if growth is already sluggish.
On the demand side, interest rates affect consumer behaviour. Two major boosters for industrial growth on the demand side come from mortgage finance and auto cum consumer durable loans. When people borrow smaller quantities of money when rates go up, then the demand for housing comes down. This has a backward linkage effect on the cement, steel, machinery and electrical equipment sectors. Lower demand for consumer durable goods and automobiles will again affect the auto and ancillary sectors, durables segment, steel, glass, machinery and electrical equipment industries thus calling... for a review in expansion plans.
RBI has hence, definitely opted for the inflation path and has put the growth objective on the sidelines. But, the perplexing part of the policy has been the move to increase the CRR. Banks presently are facing a shortage of funds and are making use of the LAF facility to the tune of around Rs 30,000 crore. By raising this rate, RBI will be forcing banks to borrow more from the RBI through the repo window where there will be paying a higher price. It is hence a double whammy for the banks that have fewer resources to lend as RBI is impounding resources on which no interest is being paid. Further, they have to borrow the same funds from RBI at a higher rate now through the repo window.
What are the likely effects of these moves? The first is that the banks' profitability will be affected as their cost of funds goes up and they have to book losses on their investment portfolios. The industry will invest less now, which will impact overall GDP growth. Inflation may be tempered, but that will mainly be due to better supply conditions and only partly due to the monetary squeeze. Individuals however, can be happy that they are less worse-off than that before as their real interest loss narrows down. But no real gainers, only losers.
Taking any policy decision on the 29th was going to be a tough decision considering that the RBI had to really toss for either inflation or growth. Growth appears to be a downward path and inflation well entrenched at a double-digit mark. As neither lower growth nor high inflation are acceptable, especially since the next general elections will hopefully be held against the backdrop of these two numbers, the rational belief was that RBI would do nothing to hurt growth, while inflation would be guided by past policy decisions as well as improvement in real sector supplies.
By opting to increase the CRR and repo rate, RBI has made it clear that it is antagonistic towards inflation. Further, by talking of a rate of 7% towards the end of the year, it does hope that these measures work.
There are two parts to this story, which is the case with all monetary policies. One needs to closely look at both inflation and growth.
Inflation today is a cost-side driven phenomenon and therefore cannot be directly affected by monetary policy. If there are shortfalls in foodgrains production or oilseeds output, no amount of monetary tightening will help. Money supply growth is increasing but the growth in credit is more due to the higher lending to the oil companies rather than an industrial revival. In fact, as discussed later, industrial growth has slowed down. Such lending will carry on nonetheless as it has to be done.
There can be two explanations behind raising interest rates to control inflation. The first is that inflation has now reached a stage where there are negative real interest rates. With inflation ruling at 12% a deposit holder with an interest rate of 10% is actually still in the negative territory by 2%. But, by raising the interest rates by 50 bps we are only narrowing the gap and not eliminating the same. In fact, if this is going to be a policy decision, then there are hard times signalled for the future. The second reason could be that RBI would like to stifle inflationary expectations such that overall spending through borrowing is curbed, which will moderate the build-up of demand-pull forces. The thought process here is that inflation as such is not as dangerous as inflationary expectations. If all expect inflation to go up, and then inflation will move up - a self-fulfilling prophecy. By raising rates now, people will automatically spend less, thus either reducing demand or deferring the same, both of which will lead to lower inflation. This is the approach the European Central Bank has also taken when increasing its benchmark rate a while ago.
However, what is interesting here is that since March 31, 2008, RBI has increased the CRR by 125 bps and the repo rate by 75 bps (before this policy). But, inflation has not really come down and remains in the double-digit level. While it is not clear as to the exact time taken for these measures to bear fruition, it is felt that the period would vary between 2-4 months. Therefore, if these rate hikes have to work, they should be doing so now.
The second part of the story is growth, and industrial advance has been tardy during the first two months of the year, and the symptoms are not too encouraging. There are no real signs of large investment taking place. Overall corporate performance appears to have slowed down this year and the increasing interest rate regime is part of this story. By raising rates further, there is a possibility of the slowdown becoming more acute.
High interest rates affect the industry on both the demand and supply sides. On the supply side higher rates increases costs for companies, which may prompt them to defer investment plans, especially if growth is already sluggish.
On the demand side, interest rates affect consumer behaviour. Two major boosters for industrial growth on the demand side come from mortgage finance and auto cum consumer durable loans. When people borrow smaller quantities of money when rates go up, then the demand for housing comes down. This has a backward linkage effect on the cement, steel, machinery and electrical equipment sectors. Lower demand for consumer durable goods and automobiles will again affect the auto and ancillary sectors, durables segment, steel, glass, machinery and electrical equipment industries thus calling... for a review in expansion plans.
RBI has hence, definitely opted for the inflation path and has put the growth objective on the sidelines. But, the perplexing part of the policy has been the move to increase the CRR. Banks presently are facing a shortage of funds and are making use of the LAF facility to the tune of around Rs 30,000 crore. By raising this rate, RBI will be forcing banks to borrow more from the RBI through the repo window where there will be paying a higher price. It is hence a double whammy for the banks that have fewer resources to lend as RBI is impounding resources on which no interest is being paid. Further, they have to borrow the same funds from RBI at a higher rate now through the repo window.
What are the likely effects of these moves? The first is that the banks' profitability will be affected as their cost of funds goes up and they have to book losses on their investment portfolios. The industry will invest less now, which will impact overall GDP growth. Inflation may be tempered, but that will mainly be due to better supply conditions and only partly due to the monetary squeeze. Individuals however, can be happy that they are less worse-off than that before as their real interest loss narrows down. But no real gainers, only losers.
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