Inflation an issue for investors, industry says high rates will erode competitiveness.
Economists are a divided lot. And, this time the central bank’s recipe to control inflation has divided the community further. As an economist with a corporate house says, “In order to understand the divide, it’s important to know where the prescription is coming from.” Interestingly, corporates are alleging that though a high interest rate regime helps shore up the bottomlines of bankers, it will render the industry’s competitiveness in the medium term. This seems to be well demonstrated in the credit offtake by the private sector. Generally, credit extended by the banking system to the sector has a strong correlation with economic activity. And, if the central bank remains hawkish, growth will be the clear victim. Statistics show that between financial year 2003-04 and 2007-08, the average ratio of credit growth to nominal GDP growth was 1.6, implying a substantial deepening of credit in the economy. However, since the crisis, the ratio has averaged only 1.1, as headwinds to the economic recovery continue to deter credit growth. Standard Chartered believes this ratio will edge up marginally to 1.2 in 2011-12, implying credit growth of around 20 per cent.
While the interest rate cycle has gone back to the pre-crisis levels, it’s the dramatic increase that has hurt companies more. If this continues, many corporates believe they will have to resort to external borrowings as the cost of capital is significantly higher in India. However, with the global interest regime looking up, corporates may even lose that window of raising low cost capital.
While India Inc’s woes are not without basis, most other economists believe there is a method to the central bank’s rate increases. The Reserve Bank of India does not want companies to pass the entire cost push to the consumers due to the strong demand. Therefore, by increasing rates, it wants to put pressure on margins and this will subsequently slow down demand. While, in the short-term, companies will be affected due to thinner margins, this will go a long way in curbing inflation. Says the chief India economist of a leading investment bank: “Investments don’t flourish when inflation is volatile. Whenever there is high inflation, growth has to slow down.”
However, both industry and bankers are unanimous on the issue of the government inaction on curbing supply-side shocks. A lot of inflation has been driven by the government’s policies on wage increases. While managing the supply chain in food is easy, if farmers fail to get decent prices after a bumper crop, they will again move to other lucrative crops next year.
