Corporate results argue for a rate cut

Prima facie, there is ample room to cut with inflation well below the RBI's target levels

Is the recovery cruising along comfortably? Or does it need a kick-start relatively urgently? This is a question that is crucial to evaluating the judgment delivered by the Reserve Bank of India (RBI) on the policy rate. If corporate results are looked at, then the economy definitely appears to have a demand problem. Examining a database of 1,600 companies (excluding banks and financial companies) clearly suggests that low demand and over-capacity bedevil the private sector. For this sample, sales grew at under six per cent in 2014-15. This may certainly partly reflect the fact that inflation has declined sharply; under such circumstances, the nominal revenue growth should logically be lower. But operating profits fell by 0.5 per cent, too, and net profits fell by 7.5 per cent (adjusted for extraordinary one-off profits and losses). In 2013-14, that sample saw sales and net profits grow at 9.6 per cent and 11.6 per cent respectively. It is thus difficult to say that demand is robust. Profit margins would have been even worse except that, fortunately, raw material and energy costs went down by six per cent of sales. India Inc's performance was weakest in the January-March 2015 quarter, with flat sales and a near 60 per cent decline in profits.

Debt and credit offtake numbers also show that the investment cycle is impaired. Outstanding debt decreased 3.5 per cent in financial year 2014-15 compared to 2013-14, easing down to 39 per cent of sales. The demand for bank credit grew at only 12.6 per cent, the lowest credit growth rate in 20 years. The differential between treasury yields (7.9 per cent last week for the 91-day T-Bill) and inflation is over three per cent, implying real rates of interest are much higher than desirable. Most importantly, interest costs grew by over 10 per cent year-on-year in the last quarter. High rates are beginning to cut.

Given all this, it is understandable that "everybody" wants Dr Rajan to cut rates. Prima facie, there is ample room to cut. Inflation is well below the RBI's target levels. Inflation in the Consumer Price Index is down to 4.87 per cent (April), and wholesale inflation has been negative for six months. Oil is cheap, and the current account deficit seems well under control. The RBI seems to have noted this, having already cut rates twice this year. But it has expressed dissatisfaction at the fact that banks have not transmitted those cuts by reducing commercial rates. Banks have been loath to pass on the cuts because the sector is struggling with non-performing assets (NPAs). The State Bank of India chairman says that NPAs may not have peaked yet. Gross NPAs may run at 4.5 per cent of advances by March 2016, with public sector banks most severely affected. The prime contributor to the NPAs is stalled infra projects.

This is a real conundrum. The RBI can indeed cut rates. But banks are reluctant to aggressively seek new business or even to pass on rate cuts until and unless infrastructure bottlenecks are unclogged. This is where the government has to come into the picture. Rate cuts alone cannot turn around the economy without the structural changes that get those projects moving again.