INSIGHT: Indian industry struggles with costs and growth

11 June 2012 14:52  [Source: ICIS news]

By Cuckoo James

Parliament buildings, New Delhi, IndiaLONDON (ICIS)--A cut to high interest rates may be absolutely vital in revitalising India's economy, as fresh industrial data reveal a slow start to the new financial year which started on 1 April, but it cannot be the sole step in the race to speed up growth and stimulate demand for chemicals and polymers.

Excessive government spending has been part of the problem, and a tightening of fiscal policy is long overdue.

The Reserve Bank of India, India’s central bank, is holding a monetary policy review on 18 June. Most analysts and traders in the country expect the bank to announce a cut to its current 8% main interest or repo rate, the rate at which it lends to other banks. Such a move could increase much-needed liquidity in the struggling industrial sector and boost economic growth.

The monetary policy review will come in the wake of the release of possibly bleak April Index for Industrial Production data by the Central Statistics Office on 12 June.

The data are set to reveal the level of manufacturing output across the country – and could be crucial in influencing sentiment.

As an early indication, the Ministry of Commerce released data showing that India’s key infrastructure industries grew by a mere 2.2% in April from a year ago. This is not a promising start to the new financial year, after growth dipped to its slowest pace in nine years in 2011–2012.

India’s industrial sector has struggled over the past few months, especially with high costs from a rising crude oil import bill and a credit crunch as a result of the high interest rate.

India’s crude oil bill is high because the country has to import most of its requirements, an executive at one of India’s largest oil importers, Reliance Industries, said.

Reliance sources its principal raw material – crude oil – from various parts of the world, including the Middle East, West Africa, the Mediterranean and Latin America. The bill is especially costly at times when the Indian rupee sustains a series of falls against the US dollar, as happened recently.

On 31 May, the rupee fell to a record low of 56.52 against the dollar. It remains Asia’s worst performing currency so far this calendar year.

Interestingly, high costs from a falling currency or high interest rates have not dampened demand among India’s rising middle class, it has merely created a supply/demand imbalance which in turn has fuelled inflation. India’s inflation rate was 7.23% in April.

In a bid to rein in inflation, the central bank has continuously increased the repo rate for the past three years. But in a drastic policy change, it was forced to cut the rate for the first time in three years in April this year, in order to boost growth.

The repo rate was cut by a sharper-than-expected 50 basis points to 8% in April. A lower repo rate means more liquidity for industries – and potentially more consumption and more investment.

It is this shift in the bank’s monetary policy – and its attempt to juggle growth and inflation – that has led traders and analysts to expect a further cut this June.

Additionally, oil prices have fallen by a sharp margin to $100.30/bbl for July Brent at the time of writing.

Considering the contribution of the oil import bill to inflation, a rate cut would be safer now than before. The rate cut became widely expected following the release of India’s first-quarter growth data, which showed that GDP growth had slowed to a nine-year low of 5.3%.

But concerns about India’s important agricultural sector could hold back the rate cut, as a supply-driven inflation is yet to relax there. Besides, traders in the industrial sector suggest the central bank’s monetary policy alone is insufficient to control inflation.

“The Reserve Bank of India cannot alone control economic growth and inflation as it does not have control over other government spending. Increases in government spending will result in more income and more money in the hands of people, thus resulting in high inflation. There thus needs to be a balance between monetary and fiscal policies,” said Mathew George, chief manager and head (petrochemical exports) of India’s state-owned Indian Oil Corporation.

Government subsidies are the holy grail of Indian fiscal policy. Subsidies on food, fertilisers and petroleum products account for the majority of the subsidy bill, and the subsidies are seen as extremely wasteful due to poor management.

In its India Economic Update 2012, the World Bank suggested the rationalisation of government expenses by replacing government subsidies with commercial investment in well-targeted areas.

Finance Minister Pranab Mukherjee in May this year promised to reduce the subsidy bill to below 2% of GDP in fiscal year 2012–2013, from its current 2.5%, and further down to 1.75% of GDP in the next three years. This could result in less expense at a time when revenue is falling, while ensuring that well-channelled private sector investment will ease some of the supply pressures that are causing inflation.

“Unless supply bottlenecks are addressed and adequate steps taken to ensure enough supply, the [bank’s] moves to curb inflation will have a minimal effect,” Indian Oil’s George added.

Read Paul Hodges’ Chemicals and the Economy blog
Bookmark John Richardson and Malini Hariharan’s Asian Chemical Connections blog

By: Cuckoo James
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