The economy seems to be slipping further into the trough rather than coming out of it. Thursday brought more than its fair share of bad news ? a fall in factory output of 1.8%, a badly dented bottomline for Tata Motors, the biggest ever quarterly loss at IOC and a near R10,000 crore loss at HPCL. More than half the companies in the BSE 100 have missed estimates ? GVK, Pantaloon, Tata Power, Indian Hotels, SAIL, Bharti, the list goes on. The management commentary from Tata Motors, which turned in a sad set of numbers for the June quarters, was far from cheerful; demand for the heavy and medium-commercial vehicles, a proxy for the Indian economy, it said, was under pressure.
After the June IIP number though ? on a three month seasonally adjusted basis IIP fell 1.4% in June ? it is the Reserve Bank of India (RBI) that will be under pressure to cut interest rates. While the weak trend in capital goods is well documented, the really bad news is that intermediate products grew at just 1.6% y-o-y and consumer goods at just 3.5% y-o-y. In fact consumer non-durables contracted. Meanwhile, the rise in prices continues without a pause even though there has been no hike in the price of diesel; headline inflation in June came in a shade below expectations at 7.3%, but the fact that RBI has upped its inflation forecast to 7% by March from 6.5%, tells us which way it expects prices to head. Indeed, core inflation is tipped to head higher from the current 4.9% while consumer inflation will probably stay in double digits. Of course, the RBI simultaneously lowered the GDP growth forecast to what now seems an optimistic 6.5%, but clearly, inflation is its top priority, since it believes sustainable growth is only possible with moderate inflation.
However, the market seems to be hoping the new finance minister, an old hand in North Block, will convince the RBI to change its mind given that GDP might grow at just about 5% after a weak monsoon. There are many who argue that high interest rates haven?t really managed to tame inflation and that lower rates for existing borrowers, especially smaller companies, would ease the strain on cash flows. The RBI really has very little room to cut rates and if at all it eases monetary policy, the finance minister would have to keep his end of the bargain, hiking diesel prices immediately so as to rein in the fiscal deficit, which he has promised to do.
Although politically difficult, the government might want to work hard to push through the diesel price hike. For one, it could convince the rating agencies that it is serious about fiscal discipline as it would the stock market.
That, in turn, would help the FM raise money through disinvestments; corporates too can pick up some equity. A downgrade, on the other hand, would immediately push up borrowing costs for companies in the overseas markets and chase away FIIs from the equity markets. A lower subsidy bill would also leave enough liquidity for the private sector?since the government would not borrow more than it has said it would? and keep interest rates in check.The brunt of the slowdown in the economy today is being borne by the state-owned banks which are recasting enormous sums as over-leveraged companies fail to meet their commitments. The situation cannot be allowed to worsen.
