Friday, June 8, 2012

NEWS & VIEWS TODAY = 09th, JUNE, 2012 = RATE-CUT or NO RATE-CUT = Why the confusion? = GST – WILL IT BE A REAILTY THIS YEAR?

09th, JUNE, 2012

Why the confusion?



VIEWS : Just the other day, another DG of RBI, Sri Subir Gokarn had said - there is room for rate-cut. In a democracy, everyone is free to voice his or her opinions. But, sometimes, when people in authority – with decision making / influencing powers make statements, they are read as the decision (that is likely to come in). Personally, I tend to agree with Sri Subir Gokarn. 

With Repo Rate standing at 8% and Base Rates at 10-10.5%, the actual lending rates to corporate and Firms to raise capital – can be higher by around 4-5% approximately, compared to an year ago.  

The immediate concern for the Nation is Growth Rate coming down sharply - and likely to come down further too. 

Growth Rate is closely linked to NEW CAPITAL ASSETS FORMATION.

Now - Low capital asset formation can result from 2 factors 

(i)           Cost of capital is too high and Return on capital not high enough to enthuse entrepreneurs to take the risk of investing in capital assets 

(ii)          Demand for consumer Goods is not growing strong enough and outlook for future not good enough to warrant creation of additional capital assets. 

Which of them is true – in the current Indian context?

There is definitely no indication that demand for consumer goods is not growing. But the Demand in India is highly price sensitive. With hike in Petrol Prices, the demand for Petrol cars has fallen steeply and manufacturers have promptly reduced manufacture of Petrol Cars. And, demand for 2 wheelers is growing proportionately. Many may have stopped their intended purchases too. 

This is the scenario in many cases, including vegetables, pulses etc.  The Growth of real Incomes is not sufficient enough to absorb the effects of such steep price rises.

The lack of new capital assets formation, by itself, gives rise to lower employment levels, lower growth of demand and hence lower GDP Growth - which again leads to the same cycle-taking the economy downhill with the end of each cycle. 

Capital asset formation is therefore a key factor in a Nation’s growth. There can be no growth without NEW capital assets formation. When additional capital asset formation comes down drastically – as in the present times, the real capital asset base may even shrink – due to depreciation factor.

No Nation can afford to ignore the need for strong (Net of Depreciation) capital assets formation, without which, Growth is bound to slow down,  or, even turn negative in real terms  ( if we factor in Inflation Rates also).

Now, what can spur the capital assets growth? Obviously, a reasonably attractive rate of Return on capital – without which there is no incentive- for entrepreneurs to enter into asset formation activity.

It is in this context that we need to view the current Repo rates and the consequent final lending rates of Banks, who will any way keep their margins (difference between borrowing and lending rates). These lending Rates roughly amount to the COST OF CAPITAL for the borrowing Corporates.

If Base Rate stands at 10-10.5%, and Inflation Rates stand around 7% (down from double digits earlier), readers can easily guess what is the REAL COST OF CAPITAL (adjusted for inflation). Most Industries do not have this level of returns on capital. 

For this reason, many corporate use bank loans only for working capital requirements now. The Growth Rate of advances to corporates especially is not strong enough in recent quarters for most Banks. Add to it, the restructuring woes of many Industries - from the view point of both corporates and Banks. Then, we can see a better picture of why corporate are not borrowing for capital asset formation, and why, they are not able to service the Debt adequately.

If Bank rate is down by say, 3%, the need for restructuring itself may not arise. The Industry itself will turn much healthier. Their products will be much more competitive in Indian and international Markets (vis a vis Chinese etc). They can sell more at cheaper rates, make more profits, generate more demand, and then, go for further capital assets formation.

My LOGIC tells me that – RBI must reduce interest rates forthwith by around 3% at one go, to encourage capital asset formation and stimulate Growth.

Incidentally, Inflation should not be the criterion now - to reduce these rates by RBI. RBI and the Industry must tell Governments (at Centre and in states) to use all possible fiscal measures at their end to reduce Inflation.

There is an unhealthy race among the Governments to tax more and more, wider and wider – and then, spend them on TOTALLY UNPRODUCTIVE SCHEMES, leading to Inflation. If the unproductive schemes (not subsidies) are cut by half, or, at least made productive – inflation will come down.

RBI must advise state and central Governments to this effect. This inflation cannot be cured by REPO RATE HIKES. But, REPO hikes bring down Growth without an IOTA  of doubt. This is what is happening. 

CONCLUSION :- RBI must bat for GROWTH, and reduce interest rates by about 3%  immediately -  before Growth hits further LOWER levels. With S&P threatening to downgrade India from Investment Grade Rating, it is much more essential Now that both Government and RBI show clear signs that GROWTH will pick up from now on and that both are intent on accelerating Growth.

2.    STANDING COMMITTEE REPORT ON GST : -Mr. Yashwant Sinha, head of the Parliamentary standing committee on Finance says – they will submit the report soon – for a constitutional amendment to facilitate the implementation of GST.

VIEWS :-It is our hope that by this year end, GST may become a reality. It is a good Tax reform. It is of course a Major Tax Reform, if UPA is able to implement it.

But, I do not expect GST to be a great boon to Industry in the long run. Governments accustomed to seek widening and strengthening the tax base are bound to hike GST also – and spend the extra revenues on unproductive schemes. Yet, Industry will be happy to deal with one tax department rather than multiple ones. 

The practice of spending huge tax revenues on unproductive schemes must stop and Governments must see how they can impart equal benefit to people even while making the schemes sufficiently productive.

Plan schemes and capital asset building measures are coming down to a trickle, while unproductive schemes and populist measures are increasing every year – which are the twin causes of current Budgetary deficits.

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