The slump in manufacturing growth in the first half of this fiscal (2012-13) is in sharp contrast to the 12-14 per cent growth envisaged in the New Manufacturing Policy. Even the long-run growth trend in the index of industrial production (IIP) is below its potential. Average annual growth rate in IIP during FY 2001-2012 was lower than that of GDP.
Explaining this downturn in terms of interest rates and slowdown in reforms will be an oversimplification. Persistent subdued IIP growth and low capital expenditure (capex) are the outcome of:
Large businesses’ greater reliance on outsourcing/importing than undertaking manufacturing and manufacturing investment; and
Higher propensity of banks for large corporate loans and consumption-oriented retail lending at competitive rates against lower propensity for MSME loans even at higher interest rates.
The cumulative impact of the non-convergence between the working of the credit architecture and industrial sector is increasingly reflected in dismal industrial growth and pessimism about its growth trajectory.
Strong economic fundamentals, high domestic consumption demand and depreciated rupee are of limited help in stemming the slide in industrial growth, capex and export. This is in contrast with China with an industrial growth of 9 per cent or so and positive export growth even in these days of global economic downturn and relatively stronger currency.
Policy Transmission
Crucial channels of monetary policy transmission work through effecting changes in aggregate credit availability and interest rates. Trade credit (TC) or B2B credit network is the largest credit system in terms of size, activity and inclusiveness in meeting the working capital needs of firms of all sizes in our country.
However, the volume of trade credit is less sensitive to policy rate changes. As such, aggregate credit availability is more influenced by the summative decisions of businesses with regard to supply and demand of TC than policy rate changes. Hence, reliance on monetary policy tools to stimulate the economy may not work to the desired extent.
Even bank interest rates are less sensitive to policy rate changes. An analysis of monetary policy transmission effects during the benchmark prime lending rate (BPLR) era shows the disconnect between the BPLR regime and policy rate changes.
Even now with the base rate regime, cut back in the cash reserve ratio (CRR) by 150 basis points (bps), repo rate by 50 bps and statutory liquidity ratio (SLR) by 100 bps since January 2012 have not resulted into proportionate cut in base rates by banks. Further, some of the banks have not reduced their base rates at all and some others have reduced it for selected categories of borrowers.
BPLR trend
A study of BPLR and actual lending rates of the banks show that as on September 2009, against a BPLR of 11-13.5 per cent for public sector banks, actual lending rates ranged between 4.2 per cent and 18 per cent.
For private banks, actual lending rates ranged between 3 per cent and 29.5 per cent against their BPLR range of 12.5-16.7 per cent.
RBI’s Working Group on BPLR had indicated that sub-BPLR lending ranged from 69-78 per cent of bank lending during 2006-08. Some of this lending by banks were at rates which did not make much commercial sense. High disparity in interest rates impact credit allocative efficiency of banks. Wide interest differentials across firms and sectors cannot be entirely justified by risk-based pricing. Price discovery in the credit market is not efficient and effective enough.
Banks’ excess holding of SLR running into over Rs 3-lakh crore, substantial investment in ultra short-term low-yielding schemes of mutual funds, high exposure to infrastructure (especially power utilities, etc.), year-end credit rush to large corporates and PSUs without evaluating their credit needs and end-use reflect weak risk-return matrix and economically sub-optimal allocation of credit.
An analysis of repo activities shows that in 65 out of 85 months (April 2003 to April 2010), banks have deposited their surplus funds in reverse repo which carried a low nominal interest rate.
On the other hand, globally competitive MSMEs (40 per cent export share) with higher growth opportunities (higher growth than the corporate sector, which depends on MSME vendors for inputs) do not get adequate bank credit. Rate of interest is not an issue; availability of credit is critical for the sector.
Why lowering rates may not work
Real interest rates are now lower compared to the high growth period of FY 2004-08.
Many large corporates are sitting on large cash and bank balances. RBI’s ‘Annual Financial Analysis of Public Ltd Companies’ shows that the annual average ratios of cash and bank balances and financial investment to their total assets spurted 83 per cent and 91 per cent, respectively, during 2000s over those in 1990s (see Table).
The annual average interest-to-sales ratio of the above companies declined from 6.15 per cent in 1990s to 3.13 per cent in 2000s. This shows interest constitutes a minor component in total cost of production.
Ninety-five per cent of MSMEs are outside the bank credit and, as such, policy rate changes have little direct impact on the working of the sector.
Large corporates have the alternative finance windows such as external commercial borrowings (ECBs), capital market, commercial papers, debentures, and so on.
Slowdown in capex
The level and pattern of industrial growth and investment are determined by quality, volume and direction of credit flows. Muted industry growth and low capex are essentially due to systemic imbalances in the credit architecture.
CAGR (compounded annual growth rate) of bank industry credit over FY 2001-12 was 22.1 per cent and infrastructure credit was 36.7 per cent, but both IIP and core industry growth were lower than GDP growth over the period.
It indicates less efficient use/diversion of bank credit by the industry.
Corporates backed by large funds have diversified their asset base from industry to real estate, financial investment, including mutual funds and fixed deposits with banks.
Spurt in financial activities by the corporates and growing interest in retail-chain business imply that treasury operations and trading are more profitable than production activities. This results in diversion of funds from industrial activities.
These impact liquidity, capex, growth and productivity in industry. Strong sense of optimism of higher capital appreciation and secured status of investment in realty are spurring diversion of funds even from small businesses to reality. Diversion of funds/liquidity from industrial sector increases financial sickness which is evident from rising NPAs.
Cash discounts
Illiquidity and heightened trust-deficit in B2B credit transactions result in inordinate level of cash-discounts. Ramifications of high cash discounts on industry include:
It makes credit dependent firms less competitive and encourages cash-based B2B transactions which limit the purchasing and selling capacity of firms and thereby shrink economic activities;
Trading becomes more profitable than manufacturing investment. Lower capex combined with high level of consumption demand make the economy more dependent on imports. Lower capex affects export competitiveness. The result is unsustainable level of trade deficit; and
Cash becomes game-changer. Cash-rich large firms enjoy unequal bargaining power vis-à-vis liquidity-constrained SME vendors. All these create inter-sector disequilibria which destabilise the industry growth trajectory.
Trade credit (TC) provides last-mile connectivity in credit distribution channel.
A weak TC network impedes efficient redistribution of credit across firms and, thereby, the credit multiplier.
The effects are akin to an irrigation dam system with fragile channels resulting in either excess supply or scarcity. Crop production and productivity suffer. Similarly, fragility in credit channels result in misallocation of credit across firms and its sub-optimal use.
This impacts productivity, output and credit at macroeconomic level. So, even expansionary monetary policy will have limited impact.
(The author is a Deputy General Manager with SIDBI.)