Expert Zone
Straight from the Specialists
Critical steps for a faster recovery
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The economy seems to be heading for a hard landing. The problem is not entirely of our making; partly it is the spillover of the crisis in Europe. Other Asian countries have also been affected but we were hit the hardest.
Surely, the economy was exposed to inflation for nearly 25 months now. The RBI initiated conventional measures. The repo rate was raised in 13 instalments from 4.75 to 8.5 pct. It made no change to inflation. The high cost of credit only inhibited investment. New investment, for instance, dropped from 6 trillion rupees per quarter to 3 trillion rupees.
Inflation was initially confined to select food articles. The increased expenditure on food diluted demand for manufactures and slowed down industrial growth. Further, food inflation increased wages and salaries since these are linked to cost of living, spreading inflation to all sectors.
The stock market was hit initially by the European crisis. Investors lost appetite for risk and the scramble for liquidity led FIIs to disinvest. Stock prices tanked and with the increase in demand for dollars depreciated the rupee.
These trends drastically distorted corporate finances. The fall of the rupee which increased external debt servicing and the hike in domestic interest rates took a big bite of profitability. In the July-September quarter, the margin was the lowest in the past seven years.
The problems are many. Inflation is high, stock market is down, interest rates are excessive, investment has dropped, trade deficit is too large, the rupee is low, and industrial production is nearly static. The only silver lining is a 3 pct increase in agricultural production. With these inputs, GDP growth in 2011-12 will be less than 7 pct.
Gold prices: Bubble or fundamental
(The views expressed in this column are the author’s own and do not represent those of Reuters)
Suddenly all eyes have turned to the yellow metal. Some say that it’s a bubble while others give a lot of demand-supply reasons. Fall of the dollar and other economic reasons suggest that it has miles to go.
Let me try a more fundamental way to analyse this. But before that, I need to first take you through the basics of share price valuation. Why is that necessary? Hopefully the dots will be joined in due course.
Basic finance taught us that the value of a corporate is nothing but the present value of all its future profits, till infinity. Although this model has a lot of assumptions, conceptually this seems logical.
Simultaneously, a corporate also has assets — namely, its book value. That is nothing but the value of its existing contracts, fixed assets, inventory — to name a few. The third major component for the corporate is the total outstanding borrowing.
Just to summarise, we have now created 3 variables — the value of the company (P), the price of its outstanding debt (V), and the value of the existing assets (B).
Now imagine what happens when the expected future revenue of the corporate drops. The obvious answer — a drop in the market value of the company (i.e. P). What happens next? The people who have lent money start getting panicky whether the company will be able to repay the money they have borrowed. How will that affect the total value of outstanding debt? The answer can be given in two ways. For the technically savvy, it just means that the rate at which investors discount the bond increases (due to its lower credit-worthiness) and therefore reduces the value of V. For the intuitive guys, it means that the probability of the company defaulting goes up and so I, as a lender, am happy getting back a lower amount today rather than waiting till maturity and run the risk of getting nothing.
Signs of cooling in Indian economy
(The views expressed in this column are the author’s own and do not represent those of Reuters)
This was not unexpected. The RBI has taken every care to cool down the economy with successive increases in interest rates. The results are now beginning to show.
But ours is not the only economy that is slowing down. Almost every large economy is under pressure for one reason or the other and the IMF was consequently compelled to slice off its own estimate of world GDP growth by 20 bps.
Unemployment in the U.S. has climbed to 9.1 pct and Dow Jones sank for six consecutive weeks, the longest losing streak since 2002. The investor, however, expects the fall to be short lived in the hope that the Fed, which is too eager to pump in money, will intervene. Even that is not going to lift up the economy.
Growth continues to be weak in Europe. Spain is sinking deeper into the debt crisis. With the impact of tsunami, the Japanese GDP may drop 0.7 pct in 2011. The Chinese economy is cooling down after inflation at 5.5 pct and new loans down 12 pct.
It is no wonder that the Indian economy is also losing pace. The original sin is food inflation which, in spite of the costlier credit, persists. At the end of May it perked up to 9 pct.
GDP growth in the first quarter of 2011 slumped to 7.8 pct in spite of good agricultural production. It was industry that let growth down.
Will higher interest rates lower growth?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The Reserve Bank of India (RBI) increased the repo rate by 50 bps on May 3 and there was an outburst of opinions that the rate of GDP growth will drop. The consensus seemed to be that it would drop to 8 pct, a 100 bps less than what we had been used to. Of course, May 3 was the first time in two years that the RBI raised the repo rate by a hefty 50 bps. In the earlier eight installments, the increase was only 25 bps.
Nevertheless, cumulatively that adds up to 200 bps. That had no impact on inflation and no impact on growth. Why should the additional 25 bps cause so much anxiety?
Most opinions did not contain explanations. It is relevant to ask why should an increase in repo rate hit GDP growth. How does the higher rate impact major sectors of the economy? How long does it take for the full impact to work itself out? These questions remain unanswered except for the assumed trade-off between inflation and growth.
The repo rate raises the cost for commercial banks of borrowing from the RBI. That in turn raises the cost of lending by commercial banks to their creditors with an effect on other interest rates, mainly short term.
The two classes of borrowers that are important are home buyers and industry.
Banks have been quick to increase the BPLR on loans for purchase of homes. Since investment in homes is a long-term investment, an increase in interest rates makes considerable difference to the monthly installment. Would that affect demand for homes?
Lower profits, uneasy market
(The views expressed in this column are the author’s own and do not represent those of Reuters)
On April 11, the CSO announced a further dip in industrial growth to 3.6 percent, bringing the Sensex down 189 points. That index was for February, the expectation about March is no better — which leaves the market a little cold.
The reasons for the dip are not all dismal. Possibly, the dip is mostly caused by what is generally called the base effect. Last year in February, growth had climbed to an unsustainable 15 percent. Even a good increase in production would have brought down y-o-y growth. The market is not unaware of this statistical illusion though a higher growth would have given greater comfort.
What is of concern is inflation. It pushed up cost more than price, putting pressure on margins. First, prices of industrial raw material (including agricultural raw materials, metals and petroleum products) were up in the Jan-March quarter by more than 20 percent y-o-y. These cost increases could not be wholly passed on. Surely, prices of manufacturers also increased. But that was less than the cost. Second, the sharp increase in interest payments which were about 15 percent of operating profits sliced off net profit.
What is surprising, industrial growth dipped in spite of the steep rise in exports. In February, exports were up 49 percent with import growth lagging behind at 21 percent. On average, industry exports more than 11 percent of production which should have stimulated industrial growth.
Not all corporates have been equally hit by cost inflation and interest rate. The impact has been more in manufacturing and mining than in services; and in manufacturing more in capital goods than FMCG. Capital goods production was actually down more than 18 percent.
Production was drastically cut because investment must have been on hold possibly in response to the increase in interest rate.
