Industrial Downturn- the hindu

8/13/2019 Industrial Downturn- the hindu

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Industrial downturn

C. P. CHANDRASEKHAR

Indian industry is in the midst of a serious downturn. The Index of Industrial Production, the

lead indicator of industrial production trends in the registered factory sector, contracted 2.2 per

cent in June 2012, after a 2.8 per cent decline in May. What is worrying is that this recessionary

trend is affecting key manufacturing sectors, including the once rapidly growing passenger car

industry.

According to the Society of Indian Automobile Manufacturers (SIAM), July was the ninth

consecutive month when sales of passenger cars reportedly fell relative to the corresponding

month of the previous year. Over the last financial year (2012-13) as a whole, car sales fell (by

6.69 per cent) for the first time in a decade. The reliability of these sales estimates is

questionable, but they are indicative of a trend. Production figures point to a positive 8.7 per centgrowth in the passenger car industry in July. But that seems to be merely the adjustment after

months of production declines, of which some were sharp (Chart).

This deceleration in growth seems part of a medium term trend. Between 2005-06 and 2010-11,

which covers most of Indias high growth era, passenger car sales grew at a scorching 15.2 per

cent per annum. That had fallen to 4.7 per cent in 2011-12, before collapsing last financial year.

Not surprisingly, manufacturers are responding to the recession. Maruti Suzuki has reportedly

asked some of its temporary workers at a Manesar plant to go on indefinite leave while Toyota

Kirloskar is not renewing contracts of temporary employees. Some time back Maruti Suzuki India

suspended production for a day at its Gurgaon plant, which is capable of delivering upwards of

3000 units everyday.


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There are many reasons why this trend in the passenger car industry must be disconcerting for

the government. The industry was in a sense the poster child of reform, delivering not just high

growth performance, but also significant foreign investment, new products, better technology,

some exports and competition that kept prices down. So the setback in this industry is far more

significant than a sector-specific downturn. Rather that downturn has something to say about the

sustainability of Indias high growth story.

This is especially true because of the stimulus that drove manufacturing production and

construction during Indias high growth years. Retail credit that went to finance housing

investment, automobile purchases and durable consumption boomed during those years with the

ratio of bank credit to GDP rising from around 20 to more than 50 per cent. It was this private

debt financed expansion in demand that was an important explanation of the boom. In the case

of the passenger car industry too, the principal factor factor driving demand and sales was access

to credit. Being a commodity that has resale value and can therefore serve as collateral for the

loan financing its purchase, the automobile is a prime candidate for debt finance. With banks

keen to lend, middle class consumers who might have had to wait to accumulate adequate

purchasing power, were now free to obtain credit and acquire the commodity immediately. Thus,after housing, the area in which personal loans have increased substantially is for purchases of

automobiles, resulting in a rapid increase in vehicle ownership. This factor was principally

responsible for the explosion in demand, sales and production.

A corollary of this is that the decline in demand must partly be because the credit-driven growth

in sales is proving difficult to sustain. The problem with a credit boom is that it feeds on itself.

Periods when the economy is booming boosts confidence, leading to excess credit provision by

lenders convinced that default is unlikely. This leads to an expansion of the universe of borrowers

to an extent where the proportion of potential defaulters or subprime borrowers exceeds some

critical level. When either evidence of overexposure or signs of rising default emerge, the retreat

of overexposed lenders can be sudden. That is possibly happening in India, where a host of otherindicators like inflation, a rising current account deficit and a weakening rupee are sapping

confidence. This tendency can be cumulative, since slowing growth is accompanied by rising

default.

In sum, what the experience in the automobile sector could be pointing to is that the confidence

required to keep growth going is waning. It is widely accepted after the 2008 crisis that growth

and accumulation under a neoliberal regime ride on bubbles, facilitated by excess liquidity and

credit in the system. In India, as in many other emerging market economies, the liquidity needed

to drive incremental bank lending was ensured by large inflows of foreign capital into the

economy. Though this process of liquidity infusion has not dried up, the confidence to ride on

that liquidity to pump credit in the system seems to be on the decline. Moreover, in its effort toaddress the rupees decline the Reserve Bank of India is seeking to mop up rupee liquidity. This

together with the increase in automobile prices that the rupee depreciation entails is likely to

worsen the recession in the passenger car market in the days to come. That could intensify the

industrial downturn.


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RBIs heady cocktail

C. P. CHANDRASEKHARSHARE COMMENT(1) PRINT T+

In his Second Quarter Review of Monetary Policy, Reserve Bank of India governor Raghuram

Rajan was candid enough to admit that GDP growth in the country this year may be lower (at 5

per cent) than earlier expected, and that inflation remains a problem. The inflation rate as

reflected by the Wholesale Price Index has risen and as measured by the Consumer Price Index

remains uncomfortably high. India is experiencing stagflation, requiring the RBI to think of

reining in inflation without damaging growth further and possibly reviving it a bit. That is a

difficult call.

The centrepiece of the central banks policy response seems to be and was presented as a hike inthe key interest rate, the repo rate, by 25 basis points from 7.5 to 7.75 per cent, to address

inflation. However, that hike has been combined with a reduction in the marginal standing

facility rate (from 9.0 to 8.75 per cent) and a measure to infuse additional liquidity into the

banking system. The latter consists of increasing the liquidity provided through term repos of 7-

day and 14-day tenor from 0.25 per cent of net demand and time liabilities (NDTL) of the

banking system to 0.5 per cent with immediate effect.

Compare this with what the RBI governor did when he undertook the mid-quarter review of

monetary policy this September. Then too he chose to hike the repo rate from 7.25 to 7.5 per cent

arguing that the battle against inflation had not been won. On the other hand, he chose to lower

the interest rate on the Reserve Bank of Indias marginal standing facility (MSF). Soon thereafter,in early October, the RBI strengthened its liquidity enhancement measures aimed at increasing
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bank access to lower cost funds by: (i) further reducing the MSF rate by 50 bps to 9 per cent; (ii)

conducting open market operations (OMOs) involving the purchase of government securities to

the tune of Rs. 9,974 crore to inject liquidity into the system; and (iii) providing additional

liquidity through term repos of 7- and 14-day tenors for a notified amount equivalent to 0.25 per

cent of net demand and time liabilities (NDTL) of the banking system. There are clearly signs of

addiction to an unusual cocktail of policies involving an anti-inflationary hike in the key interestrate combined with increased access to cheaper liquidity.

What explains this choice of a combination of apparently conflicting measures? The repo rate is

the rate at which banks borrow from the central bank against collateral that consists of excess

holdings of securities that can serve to meet statutory liquidity ratio (SLR) targets. If banks are

pushing credit, however, leading to a significant rise in the credit deposit ratio, then they are

likely on occasion to need more liquidity than they can get by pledging/temporarily selling their

excess SLR-type securities.

To increase bank access to emergency liquidity so that they can keep pushing credit even if at

slightly higher interest rates, the RBI had in 2011 established the marginal standing facility(MSF), under which banks can borrow against securities they hold as part of (and not just in

excess of) their SLR requirements, subject to payment of a higher penal interest rate and with a

ceiling to the amount of such borrowing they can resort to. The ceiling on resort to funds under

this facility by banks was set at one per cent of their respective Net Demand and Time Liabilities

outstanding at the end of second preceding fortnight.

Originally the MSF rate at which banks borrow had been set at 100 basis point or 1 percentage

point higher than the repo rate. This differential was hiked to 2 percentage points in July 2013 in

a move that seemed motivated by the need to curb speculation on the rupee. The September 2013

Mid-Quarter Review of Monetary Policy partially reversed that hike by reducing the differential

between the MSF rate and repo rate to 1.5 percentage points. With the latest policyannouncement, which increases the repo rate while reducing the MSF rate, the differential has

come down to 1 percentage point. In addition, besides access to overnight funds under these

facilities, the increase in the ceiling on term repos provides an additional and longer-term source

of liquidity to the banks.

In sum, an important plank of monetary policy in recent times seems to be that of enhancing the

ability of banks to push loans by increasing their access to emergency liquidity, the requirement

for which may increase as a consequence of increased lending out of a given deposit base. The

penalty imposed for resorting to excess borrowing from the central bank has also been reduced.

So long as banks can find borrowers who are willing to pay the higher interest that lending

backed by costlier (but cheapening) funding entails, they can lend more.

This is possibly expected to support growth, by permitting lending to the retail sector for

financing purchases of automobiles, two-wheelers, durables and much else. The government on

its part has agreed to facilitate this by infusing capital into the banking system, which would also

enhance their lending power. In this way, the RBI expects to address inflation as well as back

growth. While growth may be supported by credit-financed personal expenditures, it is unclear

why the demand this generates would not add to inflationary pressures just because the repo rate

is being hiked. Reading between the lines the argument seems to be that this would result in the

higher repo rate anchoring inflation expectations, whatever that nebulous phrase may imply.


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Is there a flight of capital from India?C. P. CHANDRASEKHAR


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In principle, direct investment is treated as being that by investors with a long term interest in

dividend returns from the country and portfolio investment as that by investors with short term

horizons and interest in capital gains. This is expected to make the former more stable and latter

more volatile. The evidence suggests that this is not a distinction the categorisation actually

makes. Even investment categorised as direct includes a component that displays volatility.

Were the uncertain economic conditions resulting in the exit of capital from India also

responsible for the decline in investment abroad by residents? This does not seem to be case

(Chart 3) since the decline in assets held abroad by resident agents was not the result of a fall in

foreign direct investment by them but because of a decline in the foreign reserves held by the

central bank. On the other hand, resident investment abroad remained stable. That is Indias

asset holding abroad fell because the Reserve Bank of India was using a part of its reserves to

stabilise a weakening rupee, even if unsuccessfully. Reserve assets fell by $9.6 billion during

April-June 2013 compared with the immediately preceding quarter.

This has implications for the factors responsible for changes in Indias international investment

position. It could be argued that foreign investors were pulling investment out of India because ofexternal developments, such as the possibility that the Federal Reserves policy of quantitative

easing would be tapered down, with a reduction in the access of investors to cheap money. But,

even to the extent that this was true, the impact of that on the Indian rupee would depend on how

important such investments were for financing India balance of payments. Given Indias large

current account deficit, or excess of foreign exchange expenditures over foreign exchange

earnings, those flows were indeed important. As net flows turned negative, the current account

deficit emerged an important and more fundamental explanation of the rupees weakness. And it

is that weakness that partly triggers the fall in the reserve assets held by the central bank.

A large current account deficit and a weakening rupee also adversely affect investor sentiment,

which (besides external factors) contributes in turn to a decline in foreign investment in thecountry. So while capital flight from India does matter when explaining the rupees position and

the uncertain economic environment, the countrys balance of payments position is the more

fundamental weakness that can and needs to be addressed.

Industrial Downturn- the hindu

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