The basic presumption of high-cost credit adversely affecting the flow of investment in the economy has not been eloquently proved by events in the past six months.
The latest monetary policy of the Reserve Bank of India (RBI) has left the repo rate unchanged at 5.15%. The previous 135 basis point (bps) reduction in the rate by RBI in the last nine months has not made any appreciable impact in cutting down the prime lending rate and hence could not facilitate investment and credit-linked consumption.
The basic presumption of high-cost credit adversely affecting the flow of investment in the economy has not been eloquently proved by events in the past six months. There is no immediate response from private corporate sector to come forward and invest; now the interest rate is coming down. The rise in retail price (CPI) in October 2019 to 4.62% sounds a warning for the monetary policy authorities against further softening of prices by lowering the repo rate.
The declining rate of gross fixed capital formation (GFCF) as a percentage of GDP from 29.5% (current prices) in Q3 of FY19 to 27.8% in Q2 of FY20 and the drop in repo rate from 6.5% in February 2019 to 5.15% in November 2019 does reflect the reverse correlation between the two macro indicators. The conclusion, however, is not direct as investment is influenced by lending rates of the banks which failed to follow the trend of repo rate fluctuations.
For instance, against 135 bps cut in repo rate during February-November 2019, the weighted average lending rate (WALR) on fresh rupee loans has come down by 44 bps only during the period. This transmission rate must be enhanced to facilitate investment and spending.
Apart from shortfall in investment, another driver for commodity demand is consumption expenditure. Indian economy, unlike China and a few other emerging economies, is led by consumption (currently 69.4% share including government in GDP). The PFCE as a per centage of GDP has grown 8.3% in FY19, while in Q2 of FY20 the rate has fallen to 2.7%.
The expenditure shortfall may be accumulated in terms of financial saving or buying of equities, gold by the household segment which does not add to any physical assets. The government component of consumption expenditures has grown by 12% in Q2 of FY20, against 9.2% rise in FY19.
In a way, it has sustained partially the consumption of steel and cement during the period. It is gratifying to note that PMI for manufacturing in India has marginally moved up from 50.6 in October 2019 to 51.2 in last month on the basis of improved work order booking. It should continue a rising trend in the coming month to drive forward the demand.
The wholesale price index (WPI) in base metals has come down by 9.8% in October 2019. However in December 2019, an increasing market absorption of steel price hike is visible as price has grown by Rs 1,250-2,000/ per tonne range. This is a good beginning for steel manufacturers (ISPs, small and medium units) which have been suffering from price decline in the past few months due to poor demand from various sectors.
As construction and infrastructure sectors (real estate, road, rail, ports, irrigation, oil and gas) comprise around 68% of total steel flow in the economy, the gross value added (GVA) in construction and manufacturing are two major indicators for steel consumption. In FY19, the GVA in construction has grown 8.7% which came down to 4.6% in H1 of FY20, while GVA in manufacturing that grew 6.9% in FY19 slipped to (-) 0.2% in HI of the current year.
The positive impact of sharp reduction in corporate taxes is yet to be felt in raising private corporate sector investment. It is felt this policy must be accompanied by corresponding fall in banks’ credit rate. It must be mentioned, however, in favour of stickiness in prime lending rate by banks, stressed assets in credit financing have been on the rise in the past few years. Power and steel sectors together comprise around 30% of the stressed assets of banks and within the metal sector, steel happens to have maximum exposure in stressed assets. Steel consumption in November 2019 has risen marginally by less than 1% compared to the corresponding month of last year. The growth is visible in non-alloy segment (+ 4.3%) and much less in alloy/SS segment (-35.1%).
The stock level by major producers has decreased around 48,000 tonne in October-November 2019. Taking the first eight months, the finished steel production growth has risen around 2% (pulled down by a massive production decline in alloy/SS sector) compared to April-November 2019, the finished steel imports falling by 5.3% and exports growing by 34%, the total finished steel consumption has observed around 3.6% growth over last year. The significantly lower output of auto sector (15.3% decline in total auto production in April-October 2019) and negative growth in consumer durable sector (5% decline in output in April-September 2019) have led to severe lack of orders for the alloy/SS sector.
With the government announcing shortly a few other stimulus measures including personal income tax, the investment and expenditure scenarios are likely to impact positively the demand aspects of the commodity sector. Rising trend in global steel prices, demand growth in Chinese domestic market would enable Indian steel exports to march ahead of a record export growth in FY20.
(Views expressed are personal)