T N Ninan: Cool, not chill

WEEKEND RUMINATIONS

A year ago, the nervous observer of the Indian corporate scene might have been forgiven for suspecting that the (then) three-year-old boom could be petering out. Although the results of some 3,000 listed companies were still pretty handsome, it was clear that margins were beginning to get squeezed. Today, the happy truth is that such nervousness can be put aside. Corporate results show that firms have continued to power ahead, and that demand remains buoyant in most markets. The only worry is that inflation has continued to ratchet up to a level where the word 'over-heating' suggests itself. Enter the governor of the Reserve Bank of India.

If Dr Reddy were to study the corporate scene from a medium-term perspective, India's listed companies have grown their top lines by an annual average of about 18 per cent over the last four years, while profits have surged annually by 27 per cent. Net profit margins are now running at a handsome 10 per cent of turnover. Quite simply, there has been no previous period like this one. And he should not be the one to spoil the party.

From a short-term perspective, the trick that Dr Reddy has to perform (during his quarterly monetary review) next week is to let the system continue to barrel along, while addressing the inflation problem. There is no getting away from the fact that his assumptions for the year have gone badly wrong: not only is inflation ruling above his preferred band of 5-5.5 per cent, but money supply has grown much faster than he had expected, and so has bank credit. Those numbers tell us that the governor has to act, and the obvious measure would be to raise interest rates by at least 25 basis points, perhaps more. May be other steps need to be taken too. The government has tried to do its bit by addressing supply side issues, but the baton is really in the governor's hand.

But before he makes his move, the question that he should answer is whether the numbers have gone wrong because growth has been under-estimated. In other words, is the economy growing even faster than the official numbers tell us? Everyone who knows how the GDP numbers are put together knows also that there are huge question marks over the reliability of those numbers; accurate data simply do not exist. So if one were to look for pointers in the areas where the numbers are in fact reliable, the GDP figures come across as being under-estimates. It is hard to understand, for instance, how truck sales could be growing at 30 per cent (on top of previous good years) if the non-services sector""industry and agriculture""is growing only 6 per cent. And remember that the speed of truck movement has increased because of the better roads; if anything, this efficiency gain should mean that we need fewer trucks. Exports have grown at more than 20 per cent for several years running, including this year""despite the rising rupee. And the corporate numbers do not suggest over-all growth of just 15 per cent (9 per cent plus 6 per cent inflation).

What if we were to assume for the moment that the GDP is in fact growing faster than the official numbers tell us? That would explain why the RBI governor got his maths badly wrong""the system would therefore require more money supply and more credit than he had bargained for. If on top of that the finance ministry is right in arguing that the causes of inflation this year have little to do with money supply, then the governor's task becomes more complicated. On balance, a hike in interest rates is inescapable, and banks are doing it anyway because that is the only way in which they can get more deposits to use for feeding the demand for credit. But it would be a pity if we read the macro-economic picture wrong and ended up with more draconian measures, for that might squeeze growth when there is no need to do so.