MUMBAI: On Friday, when Reserve Bank of India (RBI) governor Yaga Venugopal Reddy wielded the hammer on money supply, the reasons he gave were crystal clear: we have to douse inflationary expectations. What’s not clear is whether he is done with the blows. The major pressure points continue to exist, despite talk of inflation easing off by May.
Zooming credit: The main problem is that the brakes haven’t worked so far. Banks have raised interest rates repeatedly and the RBI has been stamping hard on liquidity, but all these moves have had little impact on credit growth. RBI data on Saturday showed that as of March 16, 2007, credit growth was nosing 29%. That’s just a shade below the average credit growth of 30.38% for the last one year, according to Bloomberg Data.
More importantly, the number is 400 basis (4%) points above the RBI’s stated comfort zone of 25% or less credit growth.
Banks and corporates continue to mop up money through floating rate notes and yen borrowings abroad. This is a double whammy for the RBI: the resultant forex inflows upend the RBI’s efforts to slow down credit growth and infuses additional rupee liquidity, which feeds inflation.
On the corporate side, interest costs at 1.7% of sales hadn’t pinched bottomlines till the December quarter because sales growth was a much faster 30-35% and operating margins were a healthy 17-18% — on ever-increasing toplines. The AAA-rated firms continue to have a large leeway here because their average borrowing costs remain in the 6-9% range.
For the smaller firms at least, things will significantly change in the January to March quarter because of the raft of rate hikes of the past four months.
Is this good enough to hard-brake the economy’s engines? We’ll get hints in the next few weeks as the quarterly results trickle in, especially from the manufacturing companies.
The forex deluge: On the other hand, the RBI’s efforts to make money cheaper by raising rates and tightening liquidity often invites more liquidity - from abroad. As interest rates head north in India, dollars at pouring in at breakneck speed. India is adding $1.8 billion a week to its forex kitty. Meaning, about Rs 7,800 crore of rupee liquidity gets injected into the banking system every week. Little wonder money supply touched an eight-year high of 22%.
And there is no reason to think foreign money won’t come in. Corporate growth has been outstanding, despite the rise in interest rates. Capitaline data show in the December quarter the average profit growth of 1,900 companies was a mind-boggling 76.7%. In the September quarter, it was 48%, and in June 33%. That’s an average growth of 52% per quarter. Not many geographies can boast of such profitability. Yes, this is a diffused estimate and individual sectors will have their own pulls and pushes, but it does bare the underlying trend of solid corporate growth.
Also, foreign direct investment (FDI) is rising fast as India tries to finance infrastructure projects. It could even end up topping portfolio inflows this year. The country needs $320 billion in its 11th five-year plan to fund infrastructure development. Some of this Rs 14,50,000 crore would be rupee liquidity in future. But that’s another story.
The return on Sensex stocks in the last financial year has been -5.95% (April-June), 17.40% (July-September), 10.7% (October-December) and -5.18% (January-March). That’s an annual return of 15.89%, or the 14th-best performance among the top 33 global markets.
Not much, but look at it the way foreign institutional investors do - between January and December, 2006, Sensex stocks returned 47%, which makes India the fifth-best performer in the world.
US self-goal: Despite the US economic slowdown in the December quarter to 2.5% from 3.5%, India’s services exports - mainly, the IT sector - have been strong, Friday’s trade data show. So expect the dollar flows from this route to stay strong - maybe even increase in pace.
After two decades of trading charges, the US slapped import duties on China, it’s biggest trading partner, last week. On Saturday, China promised retribution. It holds $350 billion of US government bonds, the largest by any country. If it stops, slows down buying or sells treasuries, the carnage can only be imagined.
After this move by the US, the way Chinese shares open on Monday will be crucial to world markets. All this, combined with escalating tension in the Middle East, which has lifted crude oil prices, has turned the global view on the dollar very negative. Which, by default. is a rupee-positive development.
These only add to RBI’s inflation worries, though in the short-term a rising rupee helps the RBI in its inflation fight - it makes imported goods cheaper. You can import more wheat, cement and pulses, key components of India’s supply-side woes - for lesser rupees. The RBI itself estimates that supply-side issues will take more than 18 months to tackle. But going the whole hog on imports may not be a good idea in an election year because a decline in agriculture prices leaves less money in the hands of the rural folk, or 70% of the country.
Inflation dilemma: After having lost the Punjab and Uttaranchal elections - in Sonia Gandhi’s words, because of high prices of consumer goods - the government has no option but to tackle the beast of rising prices as it faces more battles at the hustings. The inflation for agriculture labour is running at 9.8%. That is, 70% of the country is finding it difficult to make ends meet. Such prices often mean one thing: the unseating of an incumbent government.
At urban centres (where, too, inflation is showing stickiness at 6.5% levels since the last three weeks), rising interest rates haven’t reduced demand for goods drastically (four new cars will be launched this week, starting with the Mahindra Renault Logan. All its makers are betting on good sales). It is a strange dichotomy — things remain quite hunky-dory in the cities, while despair increasingly drives the hinterland.
With such dynamics at work, can you envy the RBI governor’s job?http://www.dnaindia.com/report.asp?NewsID=1088244
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