Will inflation, high rates dent Indian manufacturing?

Last Updated: May 11, 2011, 13:10 PM IST

New Delhi: India`s manufacturing has had solid expansion for the past two years, but now high inflation, climbing interest rates and pinching crude prices threaten to cut the economy`s pace of industrial growth.

The Reserve Bank of India (RBI), which stepped up its fight against inflation with a bigger-than-expected 50 basis point rise in interest rates on May 3, has vowed to battle price pressures even at the cost of some economic growth.

India is not alone in facing up to the reality that gross domestic product (GDP) growth is likely to be dented in the battle against inflationary pressures that have been building in Asia as the region leads the global recovery.

Below are some questions and answers about the state of manufacturing:

WHAT IS THE OUTLOOK FOR MANUFACTURING?

Most analysts expect industrial growth to slow in the current fiscal year, which ends in March 2012, to 7.5-8.0 percent but it could slip lower. For 2010-11, the pace has been estimated at around 8 percent and in 2009-10 it reached 10.5 percent.

The manufacturing growth could, however, pick up in March and April, based on the HSBC Markit Purchasing Managers` Index for those months.

However, analysts say the central bank`s aggressive 50 bps hike and the likelihood of more increases in coming months will hamper manufacturing growth by raising the cost of borrowing funds and slowing robust domestic demand.

If manufacturing growth drops to about 6 percent this fiscal year, GDP expansion "could come down by about 0.4 percentage point," said N R Bhanumurthy, an economist at National Institute of Public Finance and Policy, a Delhi think-tank.

In a note after the interest rate hike, securities firm Nomura said focusing only on aggressive monetary tightening at a time growth indicators are already faltering "could choke growth with only a limited effect on taming inflation."

India`s manufacturing output contributes about 16 percent to GDP.

HOW MUCH OF A WORRY IS INFLATION?

It is a significant worry. Although demand remains strong so far, "inflation is really a matter of concern and could affect the manufacturing sector in the short term and investments," said B. Muthuraman, vice president of Tata Steel. He noted that higher interest costs "will be an added burden."

Industry estimates show that raw material costs as a proportion of net sales rose to 52.9 percent in the March quarter, the highest in two years, for India`s top 100 firms.

Average salaries have gone up 14-15 percent this year as firms had to raise wages, partly to offset almost double-digit rise in food and consumer prices, and to retain skilled labour.

In March, food inflation was 9.47 percent compared with year earlier while CPI rose 8.82 percent. That`s lower than in March 2010, when food inflation was 16.65 percent and the CPI rise hit 14.86 percent.

HOW MUCH HAVE COSTS RISEN?

India`s leading personal care and food products maker Dabur India said raw material costs in the March quarter were up 57.5 percent from a year earlier, and inflation would keep margins under pressure for the next six months.

Top coal miner Coal India raised prices in February by about 30 percent, putting pressure on most steel, paper and engineering firms.

Analysts say a sharp increase in prices of palm oil, copra, and sugar will impact the bottomline of consumer goods companies.

Profit margins are under severe pressure in tea, coffee, synthetic fibres, wood products, transport equipment and fuel segments, according to Nomura.

It said firms in these sectors have raised product prices and are trying to cut costs by steps such as leaving vacancies unfilled. But analysts say a bigger chunk of higher costs will be passed through to customers.

Some industries that face sluggish demand, such as steel and cement, are finding it difficult to raise prices despite a spike in the prices of raw materials such as pet coke and power.

WILL MONETARY TIGHTENING HAVE A LONGER-TERM IMPACT?

It could. Industry lobbies say more rate hikes might hurt companies` expansion plans, which would restrain increases in industrial output in future. If industries have capacity constraints but do not expand, imports will rise.

The manufacturing sector in Asia`s other big engine of growth, China, also faces issues from a battle to tame inflation. Beijing has been raising rates and is expected to keep doing so. In February, Chinese manufacturing grew at its slowest pace in six months. But annual inflation in China is running about 5 percent, so lower than India`s, and Chinese interest rates are also lower.

HAVE INVESTMENTS IN MANUFACTURING ALREADY SLOWED?

The Indian economy is operating almost at its full capacity and various analyst reports, including from the Reserve Bank of India, indicate a slowdown in investments and capacity additions by local firms.

India`s gross fixed capital formation -- a proxy for investments in economy -- eased to 27.3 percent of GDP in the December quarter from 32.2 percent in the previous quarter.

The capital goods sector, which contracted by 18.4 percent in February from a year ago, grew at 8.7 percent during the April 2010-February 2011 period compared with 19 percent a year earlier.

Bureau Report

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