India reboot

India Inc has once again raised its familiar demand for a cut in lending rates. It is not difficult to see why. Another season of corporate results is winding its way to a distinctly unhappy denouement. For 350 companies analysed by BusinessLine (‘The shaky ground beneath India Inc’s feet’, May 11), operating profits turned negative in the March quarter, as did sales growth, the third successive quarter of slippage. In this context, corporates are looking to the government and the Reserve Bank of India to come up with solutions to revive their fortunes, with a rate cut being popularly seen as the easiest means to accomplish this. In a recent interview, veteran banker KV Kamath even suggested a massive 2 per cent cut in lending rates to reignite growth. With the Index of Industrial Production slowing to a five-month low of 2.1 per cent in March, and with retail inflation showing a surprisingly strong fall, one could argue that the time is indeed ripe for a rate cut.

However, a couple of factors may prevent the central bank from effecting any cut, leave alone a deep one on the lines suggested by Kamath. The sharp fall in the rupee’s value in recent weeks may be worsened by a rate cut, with bond investors moving out of India. Further, with the met department warning of a potential El Nino impact, which will lead to a spurt in food inflation, the RBI may well choose a wait and watch policy. But any further delay in reducing lending rates may end up worsening the situation. Slowing growth is a double-edged sword which cuts both corporates and the government, since sluggish corporate performance translates into lower tax collections, which will squeeze the government’s ability to kickstart growth revival by a massive step-up in infrastructure investment. This is why the Centre has been fairly vocal in pressing for a rate cut. The turmoil in the global bond markets has forced a re-pricing with a knock on impact on stock prices. This has implications for corporate borrowing costs, which, instead of trending down, will now go up.

The situation calls for urgent intervention. The sequential fall in producer prices, as reflected in the sharp fall in the WPI, points to weak demand. This will adversely affect the pricing power of corporates, going forward, further squeezing margins, which in turn will also impact the load of bad debts banks are already carrying. On the other hand, a sharp interest cut may kickstart demand in key sectors such as real estate, infrastructure and high value durables, where borrowing costs have a marked impact on demand. A growth revival could then help ameliorate the negative impact of a poor monsoon and help sustain momentum.

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