Industry bodies lobbying for rate cuts citing US ratings downgrade, surveys

Following the US ratings downgrade by S&P and the turmoil in Europe, Indian industry bodies have started lobbying for rate cuts from the RBI. Will it succeed in halting RBI's ‘rate hike express’ that has been running non-stop since February 2010?

Industry bodies Federation of Indian Chambers of Commerce and Industry (FICCI), Confederation of Indian Industry (CII) and The Associated Chambers of Commerce and Industry of India (ASSOCHAM) have started lobbying for rate cuts from the Reserve Bank of India (RBI). The industry bodies are citing the recent ratings downgrade of the US by Standard & Poor's (S&P) and the aftermath affecting the stock markets across the globe as well as various surveys, which show effects of rate hikes on credit cost and availability in India.

"With the S&P downgrade of US debt and the possibility of a double dip-recession accompanied with anaemic growth in Europe and Japan, global commodity prices have weakened considerably. Given the global economic turmoil following the downgrading, it is important that the Indian economy is protected from the adverse effects through urgent policy action. The strongest signal that can be given to the investor community to maintain its faith in India's growth story is for the RBI to boldly cut its interest rates and provide the necessary stimulus through monetary policy action," said FICCI in a release.

Dilip Modi, president, ASSOCHAM, said in a statement, "The increased repo rates of 50 basis points (by the RBI), has not been welcomed by the market and there is definitely adverse impact on the already falling growth momentum in interest sensitive sectors, and thus it may constrain demand."

Similarly, speaking with a TV channel, B Muthuraman, president, CII and vice chairman of Tata Steel, said that the rate hike by the central bank would definitely have an adverse impact on the economy's growth. "I am definitely worried about the industry getting hit and growth momentum slowing down quite a bit," he told the channel.

ASSOCHAM and CII have also come out with a survey on micro, small and medium enterprises (MSMEs) to support their arguments for a rate cut. The CII Business Confidence Index (BCI) for MSMEs for the quarter July-September 2011, stood at 57.2 points, which represents a decline of 4.9 points from the previous quarter (April-June) and a decline of 8.4 percentage points on a year-o-year basis. "The sharp decline in the BCI for MSMEs is attributable to continuous and persistently high inflation and the anticipation that the interest rates may be further hiked by the central bank. This has certainly affected the way MSME sentiments regarding two variables-  credit cost and credit availability for capacity expansion," CII said in a statement.

Similarly, a quick survey covering 1,000 SMEs undertaken by ASSOCHAM has unanimously stated that the increased interest rates (consecutively for 12 times) have thrown many SMEs out of business and others are on the brink of being out of business.  

Since February 2010, the RBI has tightened monetary policy 12 times and increased repo rate to 8% by July 2011 from 4.75% to contain inflation. But the relentless hike in interest rates has resulted in a sharp slowdown in industrial growth (industrial growth was at 4% during April-May 2011 from 14.4% in the same period of the previous year), dip in investment intentions (number of new projects stalled to total number of new projects touched a high of 47% during June 2011 from 39% a year back) and a clear softening of bank credit growth (19.3% as of mid-July in comparison with 21.3% for the like period in the previous year).

The slowdown in industrial growth is all pervasive, with both investment demand (capital goods growth at a measly 1% during April-May 2011 as against 49.8% a in the year-ago period) and consumer demand (consumer durables goods growth at 7.9% during April-May 2011 from 27.7% in the like period in the previous year) being hit. Additionally, export demand may also take a dip, given that India's share in goods exports to the US is close to 11%.

FICCI said it is of the view that the RBI has achieved its objective of a monetary policy transmission to the real sector variables. "It is the right time now for RBI to move ahead of the curve and cut the rates. After all, India could use the current global economic turmoil to its own advantage, just at it withstood the perils of the 2008 crisis," FICCI said.

The stressful liquidity conditions peaked over September-October 2008 due to the external credit crisis, among other reasons. The RBI reacted by cutting interest rates aggressively and took other steps to ensure adequate liquidity in the financial sector. While these measures eased liquidity and revived growth, they caused inflationary pressures.

Fitch Ratings said, "While the RBI's tighter fiscal stance appears to be appropriate to contend with persistent inflationary pressures in the country, higher policy rates have begun to weigh on the economy particularly with respect to growth and liquidity."

As per Fitch's analysis of the liquidity condition, levels of various parameters used to measure liquidity are very comparable to the build-up phase of September 2008. The stressful liquidity conditions peaked over September-October 2008 due to the external credit crisis among other things. The RBI reacted by cutting interest rates aggressively and took other steps to ensure adequate liquidity in the financial sector. While these measures eased liquidity and revived growth, they induced inflationary pressures.

The repo rate was increased to 9% from 7.75% during May-August 2008, while the current repo rate is 7.5%, up 250 bps, over March 2010 level. Expectantly, the overnight call money rates surged to 7.46% in June 2011 from 3.23% in March 2010 (May-August 2008: 5.9%-9.7%).

The outstanding amount under the liquidity adjustment facility (LAF) recorded in June 2011 (Rs1,020.90 billion) was higher than the outstanding LAF observed in September 2008 (Rs900.75 billion). This provides reassurance to the RBI's willingness to supply liquidity.

However, it testifies to the relatively higher current demand for liquidity in comparison to the period September-October 2008, the ratings agency said.

However, according to economists, the central bank may not cut rates in its meeting next month as inflation is still at high levels. The annual rate of inflation, based on the wholesale price index (WPI), rose 9.22% in July below 9.4% in June. Most of the increase in the July WPI is due to the upward adjustment of administered fuel prices on 24th June.

Goldman Sachs, in a release said, "There is a slowdown in economic activity in India which is being exacerbated by rising interest rates and headwinds from the global economic environment. The sequential and y-o-y reduction in inflation numbers assumes more importance as the RBI has made future policy actions data dependent. This print may help in soothing some concerns that the rate hiking cycle will continue. We maintain our stance of a pause in interest rate hikes by the Reserve Bank of India (RBI) in FY12 and 100 basis points of rate cuts in FY13."

India's industrial production (IP) growth rose by a more-than-expected 8.7% y-o-y in June from 5.9% in May, due to a sharp rebound in capital goods production. Excluding capital goods, industrial output growth weakened further. The combined effect of weak consumption and dwindling exports will also likely start to affect upstream capital investment, which should cause an overall slowdown. "Even as signs of a growth slowdown are blinking red, the RBI will likely overlook such signs until inflation starts to moderate meaningfully. As such, we expect the RBI to hike the repo rate by a final 25 bps to 8.25% on 16th September and then stay on hold," said Sonal Varma, economist, Nomura India.

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