By
Indian firms feel the pinch amid falling inflation, high interest rates
Photo Credit: VCCircle

Indian businesses are getting squeezed. As economic growth slows and inflation sinks they have little ability to raise prices without losing sales, and yet they are getting almost no relief from borrowing costs with lending rates remaining high.

The result: profit margins get crushed. And that helps to explain why companies are not confident enough to significantly boost capital spending or hire at a robust pace.

The rise in India’ real interest rates - the comparison between the inflation rate and the rate people pay to borrow - will be a major headache for whoever wins India’s general election which lasts from April 11 to May 19. Prime Minister Narendra Modi and his Bharatiya Janata Party are expected to get a second term.

It is also an immediate problem for the monetary policy committee of India’s central bank, the Reserve Bank of India (RBI), as it decides whether to cut its official benchmark interest rate, and by how much, at a meeting on Thursday.

“Had the borrowing costs declined by 3-4 percentage points along with inflation, we would have made investments and created thousands of new jobs,” said Sudarshan Sareen, president of the All India Manufacturers Organisation.

Handicapped on global stage

Indian manufacturers pay 12-14 percent bank lending rates annually, he said, the highest among the emerging market economies. The government pays a subsidy of 3-4 percentage points to banks to lower the costs for farmers.

The facts are simple. India’s retail inflation rate has dropped to below 3 percent from more than 10 percent in 2013. In the same six-year period, bank borrowing costs for manufacturers and retailers have declined only marginally by about one percent from over 13 percent, business leaders say.

That means real interest rates have gone up in last five years. Many economists, including Ravinder Dholoakia, a member of the RBI’s MPC, have said that real rates in India are too high.

For a graphic on India's CPI inflation, RBI repo rates, see - tmsnrt.rs/2WH5xNQ

India is also suffering in comparison to international rivals.

World Bank data shows that real interest rates in India went up to 6.2 percent in 2017 from 2.5 percent in 2012, while real rates fell in many other Asian countries, including China.

India’s economy lost momentum in the October-December quarter, reducing the annual rate of growth to 6.6 percent, the slowest pace in five quarters.

New investment proposals declined to 14-year low of $138.72 billion in 2018/19, falling for the fourth straight year, according to data collected by the Center for Monitoring Indian Economy, a Mumbai-based think tank.

Modi has announced an increase in the state interest rate subsidy on bank loans for small businesses, while pushing the central bank and state-run banks to cut rates.

The RBI is expected to cut its benchmark lending rate, the repo rate by 25 basis points (bps) to 6.0 percent this week, a Reuters poll of economists showed. It has cut policy rates by less than 2 percentage points since April 2012.

Calls for bigger cuts

A substantial cut in the repo rate and bank lending rates are needed to boost manufacturing and domestic demand, and bolster economic growth, said Ashwani Mahajan, an official of the economic wing of the Rashtriya Swayemsewak Sangh (RSS), a group close to Modi’s BJP, Mahajan said that the RBI’s forecasts for the inflation rate had been consistently too high.

“The forecasts of the RBI on inflation have become a joke as they usually go wrong. The economy is paying a heavy price due to its high-interest rate policy in the name of inflation targeting,” said Mahajan, a member of the Swadeshi Jagran Manch. Mahajan said the RBI should cut the policy rate on Thursday by up to 1.75 bps, bringing the repo rate down to about 4.5 percent. The government, RSS and the Swadeshi Jagran Manch all agreed there needed to be sharp rate cuts, he said, while adding the timing and specific size of the moves was unclear.

There is also concern among government and central bank officials that commercial banks are not automatically passing through the RBI’s repo rate cuts to borrowers. India’s dominant state-owned banks are saddled with massive bad debt and weak deposit growth, restricting their ability to lend.

“Interest rates will remain elevated in India as the gap between deposits and lending is widening due to falling saving rates in the economy,” said Devindra Pant, chief economist at India Ratings, an arm of Fitch.

Leave Your Comment(s)
X