By Anjan Roy
Two years after it started raising interest rates, the Reserve Bank of India cut its policy rates on April 17 for the first time. While doing this, RBI has added a rider that given the upside inflation risks still persisting, the scope for future rate cuts were limited. So what impact can such a baby step have?
Primarily to fight inflation, the RBI had raised interest rates by 375 basis points in course of one year and seven months. At the time, RBI started its policy compression, the economy was growing at a brisk 8.4%. As the interest rates went up in successive stages, industrial production slowed down. Prices did not show any significant slackening and, in fact, kept on increasing, until about November last year, when the food prices (namely, prices of onion, vegetables and fruits) virtually crashed.
The crashing prices were by and large the end result of entire winter harvests coming on the market where the facilities for preservation of perishable items were limited. Hence, the farmers got little value for their produce. Some quantities would have been stored, but the benefits will accrue to others than farmers. There is little reason to believe that it was due to interest rate hike. Surely enough these prices have started creeping up once again and likely to scale higher in course of the summer. Nevertheless, overall price level is somewhat comfortable as manufactured items prices are trailing low.
Now that RBI has cut policy rates, will this re-start the growth process? Interest rate hike had hurt sectors which were more sensitive to interest. A hike in interest rate will leave its imprint from two sides, on the consumers’ decision to purchase and the industry’s decision to invest. Both these will in turn impact the overall growth performance of the economy.
Successive rate hikes influenced the consumers’ willingness to buy products which are typically purchased with a consumer loan. From the consumers’ point of view, we can examine three areas: home purchases, automobiles purchases and consumer durables purchases.
The first casualty to interest hike would be on home purchases as even minor changes in interest rates can have major cumulative impact on the interest obligation on borrowings. As housing loans became costlier, housing loan disbursements had reportedly fallen. The construction industry’s growth had been affected, although pick up in infrastructure projects had moderated this to a large extent.
A downward interest cycle should obviously encourage house purchases and give boost to house building. This implies that the off take of cement, steel and housing materials industries should also get a leg up. However, the question is against a hike of nearly 4%, a cut in interest of just half a percent might prove to be ineffective to really give a large thrust in house construction that is needed at present. There is of course a large segment of house construction industry which is not in formal sector and therefore somewhat immune to interest variations.
Automobile sales, which are also sensitive to interest rates since buyers invariably go for auto loans to finance their purchases, can look forward to some improvement. Automobile sales had, of course, been somewhat fluctuating in between. While, the hikes in interest rates affected potential demand, a part of the hike was absorbed by the captive loan companies of the auto producers and private sector loan givers. Besides, the expectation of fresh dollops of tax on various categories of automobiles resulted in higher purchases by consumers to avoid paying higher price in consequence of tax hike.
The consumer durables sector appears to have been more adversely affected. In 2009-10, when the monetary policy contraction started, the consumer durables industry was growing at over 17% year on year. This has gone down over the successive quarters and currently consumer durables industry growth decelerated to around 5% in the third quarter. In January and February this year (2012), consumer durables growth slipped deeply into negative territory (at -7.1% and -6.7%, respectively). Such a slide is not likely to be reversed with a half percent drop in the rates.
From the perspective of the industry, the rate hikes of last two years have left investment in the limbo. The drop in investment level in economy has already been noted by the prime minister’s economic advisory council. In 2010-11 gross domestic capital formation had declined by over 2% of GDP. Since then, it has aggravated. A proxy for this can be seen in the growth of the basic and core industries which required highest levels of investment.
Since the first quarter of 2010-11 when the mining sector, for example, was growing at 6.9%, it has come down and slipped into negative zones. In the last two quarters of 2011-12, the mining sector shrank by 2.9% and 3.1%, respectively. Intermediate goods, which are basically inputs for industry, have also decelerated sharply.
The shrinkage in mining industry output and slowdown in intermediate goods production can be admittedly be ascribed to the virtually halt to opening of new mines and various clearances for such projects. Land acquisition for these industries (like mines or steel and metals) has stopped. The minerals rich areas have been affected by civil society agitation against these projects as well as Red menace.
Coming on top of these, high interest costs have proved to be a crippling burden on fresh investment. The task at present is to push up investment in the economy and this calls for a lower interest rate regime.
RBI’s present policy could be viewed as a beginning, but needs to be followed up with further cuts. That looks dim, given RBI’s riders in its policy statement. (IPA Service)