Pulling the plug on industrial growth

The impact of these measures was sudden and severe on the industry and banks in particular. Exporters are being forced to bring back dollars. There has been a general rise in interest rates, much against the wishes of corporates. Interest rates in the inter-bank call money market — where banks borrow to maintain their reserve requirements with the RBI — have vaulted to 150 per cent and government securities (gilt) prices have tumbled. Almost all banks have hiked their prime lending rates by one percentage point. With call money rates refusing to come down, experts don’t rule out the possibility of another round of interest rate hike in the near future.

After the liquidity crisis in 1995, these are clear signs that the economy is now facing a similar problem. A host of developments like the sharp fall of the rupee, turmoil in call money markets and now the hike in prime lending rates by banks show that funds are getting depleted. Bankers said the cost of funds has now become a big question mark for the survival of the industry at large. There is a widespread fear that the hike in lending rate would push up the cost of funds to such an extent as to hit the industry.

As the capital market continues to be in doldrums, there is no way companies can raise cheap funds from the market. The number of new issues has steeply fallen in the last two years. However, the crash in South-east Asian markets and the rupee doesn’t seem to have affected the capital market for the time being. “Indian markets are insulated from the world markets. We have a margin system here … our surveillance and monitoring is also tough,” said D R Mehta, chairman, Securities and Exchange Board of India.

Even though the SEBI chairman is optimistic, foreign institutional investment (FII) has fallen in the last three months. FIIs, who burnt fingers in Asian markets, pulled out nearly $ 375 million (around Rs 1,393 crore) since November 1997. The fall of the rupee and general elections in the country have prompted FIIs to be cautious.

The recent developments would have a negative impact on the bottomlines of corporates due to the increasing interest burden. While the existing mega projects will face a severe cost escalation due to the ever rising cost of funds since the announcement of busy season credit policy, new projects with borrowed funds and imported machinery will face a dilemma thanks to the tight monetary situation and rising interest rates. “This could mean that several corporates which presented good first half results, may not sustain such a performance in the next half,” said the chief of a finance company.

Infrastructure projects which require huge funds are likely to be hit by the turn of developments. With another round of interest rate hike likely to happen in the near future, corporates are facing uncertainty. Another worry is whether funds will be available due to the tightening liquidity position.

However, IDBI chairman S H Khan said “the hike in lending rate will not affect the industry. Even though the bank rate has been raised by 200 basis points, we have hiked the PLR by only 100 basis points.”

Naturally, industry pundits are concerned. When the cost of borrowing goes up, it will be reflected in the industry’s projections also. They are not sure for how long the new RBI measures will continue. In the last two months, the RBI has taken several steps and withdrawn many to arrest the rupee slide. It is difficult to predict whether the interest rate hike will be long-term or short-term. “It is an overreaction by the RBI. It will rein in inflation at the expense of growth,” said an official of ASSOCHAM, a leading industry association.

Even within the banking system, many banks are feeling the heat. Foreign banks — with limited branch network and small retail deposit base — are perennial borrowers in the call market and have been worst-hit by rising short-term rates. Foreign banks are also concerned over the shrinking margins in India as the central bank’s tight money policy forces them to raise funds almost at the same rate at which they lend. “The excessive speculation (cancelling and re-booking forward contracts) in the foreign exchange market has come to an end following tough RBI measure. Earlier money was going from the banking system to the forex market for speculation,” said a forex dealer, adding that the incoming government might be cautious about going in for full convertibility on capital account.

Granted, the RBI has been able to rein in the rupee fall, but the forward premium on dollar has been rising. The six-month forward premium on dollar touched 19.40 per cent on Saturday — this indicates that the perceived value of the dollar for delivery after six months will be costlier by 19.40 per cent in rupee terms. This has given rise to speculation that the rupee will fall further against the dollar. “Our studies have shown that the correct value of the rupee is Rs 42 against the dollar,” said Ramu Deora, president, Federation of Indian Export Organisations.

Exporters are not really happy with the RBI package and the subsequent strengthening of the rupee to the 38.72 level from 40.25 against the dollar. Apart from the surge ininterest rates, the RBI package — which also cut export refinance limit to 50 per cent from 100 per cent — has forced exporters to bring back dollars kept abroad. There was an allegation that the dollar inflow fell — which in turn put pressure on the rupee — as exporters refused to bring dollar earnings to India anticipating further fall in rupee. “The global repercussions of the Asian slowdown should impact India’s exports negatively and we expect an export growth rate of 8 per cent for the year 1998-99,” says an analysis by Kamal Sen of DSP Merrill Lynch.

Industry pundits and exporters are not sure about many things. Will interest rates be a short-term phenomenon? Will the rupee continue to depreciate against dollar? If so, will the RBI tighten the measures again? The Indonesian rupiah has plunged nearly 80 per cent, Malaysian ringitt by 42 per cent, the Thai baht by 48 and Korean won by 46 per cent. As summed up by Bombay Stock Exchange president M G Damani: “India and China are now being seen as wise countries, which did not succumb to the pressure or temptations to open their economies beyond their absorbing capacities.” For how long, it is to be seen.