India’s Manufacturing Sector: Feeling the Heat
Monetary tightening failed to tighten the screws
Since March 2010, the RBI has raised the repo rate 11 times, moving it up to 8% from 3.75%. Yet, for a fairly long period of time it failed to impact domestic demand. This can be attributed to the following.
- RBI failed to gauge the inflation trajectory appropriately and continued with baby steps of 25 bps rate hike which could not tame the inflationary expectations adequately.
- With an inadequate expectation setting, the banking sector refused to respond to the signals and continued to keep the rate on hold. This is best exemplified by the steps taken by the State Bank of India, the country’s largest bank. SBI’s SBAR or State Bank Advanced Rate saw its first increase, five months after RBI made its first move.
Source: Reuters, RBI
However, with inflation perking up and rates rising, the banks had to finally yield.
Consumers are starting to pull back…
The consumers, who had shown a remarkable degree of resilience so far, started to pull back as the double whammy of inflation and rate hikes took its toll. Although data is available only till June, consumer loans have started showing signs of moderation, with a clear dip in the growth rate of vehicle loans.
Source: Handbook of Statistics on Indian Economy, RBI
More importantly, with the increasing opportunity cost of holding cash (given rising inflation and interest rates), the consumers are showing a clear preference for time deposits (with positive real returns, especially at the longer end of maturity) over demand deposits – indicating increasing preference for savings over consumption, in an uncertain environment.
Source: Database of Indian Economy, RBI
Overwhelming the manufacturers
With clear evidence of demand destruction happening, India’s manufacturing sector is slowing down. Domestic automobile sales fell 15.8% y/y in July, the largest decline in three years, as higher interest rates and fuel prices curtailed demand. IP growth improved in June, but this was mostly due to volatility in the capital goods sector. Stripped of this effect, the downward trend in IP continued, and the PMI data suggest the slowdown will continue. The new orders sub-indices in the manufacturing PMI have fallen sharply in recent months, with the new export orders showing a contraction in July.
Slowing demand is already hurting corporate margins. As per a report by Business Line (http://www.thehindubusinessline.com/opinion/editorial/article2384259.ece), corporate profit margins during quarter ending June 2011 rose by a mere 9.5% as against the predictable 13-15%. More importantly, the number of companies reporting a drop in profit in Jun’11 rose by a third as compared to Mar’11. This is because the so called pricing power that the Indian corporate supposedly enjoyed was a chimera. They were merely overwhelmed by the rising input costs and kept the price hike to the minimal for fear of losing demand. An analysis of the monthly WPI data shows that while input costs (primary articles, ex-food) galloped ahead (led by sharp rise in minerals, indicating the impact of rising commodity prices), prices of manufactured products just about strolled through.
Source: Office of the Economic Advisor, GoI
With margins under pressure and monetary tightening finally beginning to have its effect, credit offtake is showing signs of slowdown.
Source: Database on Indian Economy, RBI
Even the banks are treading cautiously as the threat of asset impairment looms large, especially with some corporates starting to default. Not surprisingly, the NPAs (non-performing assets) of the banks are now rising. The Reserve Bank of India has recently raised concerns about the deteriorating credit condition and has warned that the NPAs could rise by 25% this year to 2.92% of total portfolios. With worsening credit conditions, the small and micro industries in India are being choked off fund, which is not great news for India’s manufacturing.
Source: Database on Indian Economy, RBI
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