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Heading for recession

For two months anecdotal evidence has been accumulating that last April’s savage upward yank on the CRR had pushed interest rates too high and is pushing the economy into a recession, writes Prem Shankar Jha.

india Updated: Jul 13, 2007 01:34 IST

For more than a hundred years, economists have been unable to make up their minds whether theirs is a pure science or a part of the humanities. This has made economic analysis an unusually vexatious business. While political scientists, for example, readily admit that some of their most valuable insights come from intuition, economists wait till they have ‘hard facts’. The trouble is that ‘hard facts’ take time to collect and are often not really hard. By the time the economists are satisfied that they ‘have the facts’, it is often too late to do anything about them.

This is the dilemma that the Indian establishment faces today. For two months anecdotal evidence has been accumulating that last April’s savage upward yank on the cash reserve ratio had pushed interest rates too high and is pushing the economy into a recession. But economists at the Reserve bank of India still seem to be in two minds. So strong is the advocacy for a continuing tight money policy, that even the staid Centre for the Monitoring of the Indian Economy (CMIE) has felt compelled to warn its readers in its Monthly Review for June that ‘interest rates are high and any further increase can adversely affect economic growth’.

The CMIE is respected precisely because it is cautious, and therefore reliable. But on this occasion it has carried caution too far. For it is not only an increase in interest rates that will damage the economy. It is the continuation of the current rates. The average benchmark-lending rate has gone up by 2 per cent, from 10.75-11.25 per cent a year ago to 12.75-13.25 per cent today. But the real rate of interest, i.e. nominal rate minus inflation, has gone up vastly more. Between April and June 2006, the consumer price index had risen by 6.4 per cent. The real benchmark rate in July 2006 was, therefore, 3.75 to 4.25 per cent. This year the consumer price index has gone up by less than 0.8 per cent during the same period. In fact, it has gone up by under 1 per cent ever since October last year. So the benchmark ‘real’ rate of interest to borrowers today has tripled to between, 11.7 and 12.3 per cent. So whatever little justification inflation may have provided for putting a brake on money supply, has long since evaporated.

Commonsense tells us that such a sharp rise in real interest rates cannot but severely curb investment and hire-purchase financing decisions. Thus, if I were the governor of the Reserve Bank of India, I would be watching every conceivable indicator, however small or indirect, to see how the economy was reacting. The indicators are aplenty and they all, without a single exception, point in the same direction — downwards. So when a friend who is an economist, asked me in all sincerity whether the data I had been publishing might not be ‘greatly exaggerated’, I could only assume that he too had joined the ranks of the ‘pure scientists’.

Here are the straws in the wind: First, within weeks of the April interest rate hike reports began to appear in the Mumbai papers that real estate prices had begun to fall. They had, in fact, already been affected by the January interest rate increases. April only accelerated the fall. Enquiries with real estate agents in Delhi have confirmed the same thing is happening in Delhi. Prices have declined by 10 to 15 per cent in the outer suburbs of Delhi such as Gurgaon and Noida. They are holding firm in the centre of the city at present, but there had been a sharp decline in the number of enquiries. If the experience of the post-1995 recession is anything to go by, these will soften only if the recession takes firm hold and gets prolonged.

The rise in interest rates has also made a large number of housing loans go sour. So great is the damage done that, according to a report in the Business Standard on June 22, the State Bank if India, the ICICI and the HDFC, the three largest home loan portfolio holders were negotiating with the Asset Reconstruction corporation to sell up to Rs 750 crore of bad home loans , and were not likely to recover more than three fifths of that value. What this means is that in a matter of weeks the market is going to see a sharp increase in the supply of middle-class housing and apartments, with relatively few buyers. It is no surprise , therefore, that Delhi builders are hurrying to finish their ongoing projects but taking up very few new ones.

Second: On June 2, the Financial express reported that there had been 14 per cent drop in the sales of two-wheelers by the three majors: Bajaj, Honda and TVS industries. This has been repeated in June, when their sales have declined by 8.4 per cent, 13 per cent and a whopping 39 per cent respectively.

The picture in the motor car market is more mixed, because sales have to some extent been buoyed up by the introduction of a number of new models in the first quarter of the year. But numbers do not tell the whole story here, because they do not take into account the substitution of cheaper for more expensive cars that takes place when the cost of borrowing rises. Thus Maruti’s small car sales grew by 10,400 units, while even the very economical Esteem and the new SX4 together recorded an increase of only 1,250 units. General motors, long ailing in India, too staged a small recovery based on the sale of its new small car.

At the other end of the scale, sellers of premium cars like the Honda, Skoda, Toyota, Mercedes, Daimlers and BMWs, remained unaffected, either because their cars are bought on company account or because the executives who buy them would not be seen in anything less prestigious. In sum, the sale of all cars that are not subsidised by the taxpayer are already being affected. The auto industry expects sales to decline in the coming months.

With the end of the first quarter macro-economic data is also beginning to come in. Against an increase of Rs 14,050 crore in the first quarter of last year, bank credit has shrunk by Rs 33,111 crore in the last three months — a turnaround of almost Rs 50,000 crore. Almost the entire amount, Rs 30,547 crore is in non-food credit, and three quarters of this, in turn, is a decline in loans, overdrafts and advances to the commercial sector. What this means is that business is slowing down all over. People are being tighter with their money. The high interest rates have also begun to affect foreign trade and employment. In the past year, the rupee has appreciated by 13.7 per cent against the dollar and 6.1 per cent against the euro. This has worsened the balance of trade. Against $ 8.2 billion in April — May 2006, the trade deficit has surged to $ 13.2 billion this year.

Textiles seem headed to become the first calamity: In a BBC Asia programme on July 10, exporters expressed the fear they were being priced out of the garments market. Their actual production had not fallen because they were still fulfilling orders received several months ago. But they had received far fewer orders this year. They were afraid that if things did not improve they would have to lay off about 200,000 workers this year.

The time to act is now. If RBI governor Y.V. Reddy insists on waiting till October to make sure he has ‘all the facts’, on his head will be the recession that is now setting in, and the loss of jobs and disappointment of young job-seekers that will follow.