A moderation in growth of industrial output accompanied by a marked deceleration in growth of bank credit to industry. The latest statistics highlight both these trends. Do they point to darkening clouds on India?s growth horizon?
A robust industry usually results in buoyant growth of bank credit. During upbeat times, as industries squeeze existing capacity and try adding more, demand for credit increases. The opposite happens during an industrial contraction. The latest numbers show a 5% growth in bank credit till the end of October 2007. This is just about half of the 9.8% growth recorded in 2006. Within gross bank credit, non-food credit, which is largely consumed by industry and grew by 10.3% last year, is struggling to maintain a much lower growth of 5.7% this year. The IIP data for September 2007 shows a growth of 6.4% in industrial output, again just about half of 12% in September 2006. With both industrial and non-food credit growth halving to their previous years? levels, is industrial expansion showing signs of grinding to a halt?
In its mid-term review of ?Macroeconomic and Monetary Developments?, released on October 29, 2007, the RBI admitted a deceleration in credit growth. Sectorally, till August 17, 2007, non-food credit growth was lower in both agriculture and industry. Similar declines were noticeable in consumer durables, real estate and NBFCs. What is worrying, however, is the particularly sharp drop in credit growth in some key industries. In gems & jewellery, for example, a 41% credit growth in the comparable period of 2006 was more than five times that of 7.6% recorded in 2007. Rubber & plastic, metal products, chemical, iron and steel and vehicles & vehicle parts are some of the other industries that have witnessed large drops in credit growth. With credit offtake slowing in these critical segments, is it a sign of these industries going slow on expansion plans and capacity creation?
But why is credit flow to industry showing a lower rate of growth? Institutional credit has obviously become more expensive. Rising interest rates have sharply increased borrowing costs, forcing corporates to explore other funding avenues. During the last few years, Indian corporates have mobilised considerable resources through external commercial borrowings (ECBs). The latest numbers for April-June 2007 put net ECBs at $7.1 billion, much higher than $4 billion in the same quarter of 2006. Clearly, harder domestic interest rates have encouraged Indian industry to borrow more from abroad. However, recent policies aiming to confine large chunks of ECB proceeds overseas for use as foreign currency expenditure might see these inflows fall during the rest of the year.
With bank credit becoming more expensive and ECBs tighter, the capital market is the only other option for raising funds. The stock market has been feverishly bullish. During the first half of the current fiscal, there were 59 equity issues, compared with 50 in the same period of 2006-07. These included 46 IPOs. The amount mobilised through primary market issues during April-September 2007 was a whopping Rs 31,854 crore, up almost 150% over the Rs 12,770 crore raised during April-September 2006. In the secondary market, the price-earning ratios at both the BSE and NSE have improved sharply during the year. Market capitalisation has gone up by 63% during April-September 2007 as compared with April-September 2006.
There?s little doubt that for resource mobilisation, industry is pinning its hopes mostly on the stock market. In the near future, more private placements and issues are expected to hit the market, leading to higher turnovers in both the cash and derivative segments. As market capitalisation increases further, liquidity management might become more onerous, with FII inflows not showing any signs of abetting in future. And will that result in further interest rate hikes?
Any further hardening of interest rates will result in a commensurate shrinking of credit to industry. More industries will zero in on the stock market. If the Fed slashes US rates further, the interest differential will provoke more FII flows. The next quarter?s BoP numbers that will come in by the end of December will show whether the new policies have succeeded in moderating ECBs. If so, industry will turn even more to the stock market. But even if not, more capital flows will continue to exert pressure on domestic liquidity.
The capital market might not have enough space for accommodating the demand for funds from the entire length and breadth of Indian industry, particularly SMEs. Institutional credit must pick up. Higher interest rates have created big problems for SMEs as most of them do not have the wherewithal to tap the capital market or raise ECBs. Credit flow to industry has already started shrinking, as has growth of industrial output. Further rate hikes will choke off fund flow and accentuate the already visible deceleration in industrial output. And if, down the line, markets see more corrections than expected, then even the BSE and NSE might find it tough to arrest an industrial decline.
?The author is a visiting fellow at Icrier. These are his personal views