Will Reserve Bank tighten interest policy again?

Just when China is grappling over the question of "to grow or not to grow" after reporting another year of unabated expansion and bringing with it serious concerns on economic overheating, India seems to have checked its forward march to a certain extent.

The April issue of the Confederation of Indian Industry's (CII) quarterly State of the Economy Report shows that the growth in production of consumer durables during February was 1.6 per cent compared to 20.3 per cent a year back.

The report says these sectors are starting to demonstrate the impact of interest rate interventions earliest and therefore, are a significant testimony of the success of the tightening measures adopted by the Reserve Bank of India (RBI).

An obvious sign of overheating is runaway inflation. No sooner the rate of inflation started flirting with the six per cent threshold, the RBI immediately exercised caution and raised rates to suck up any excess supply of money from the economy.

The CII report obviously brings news to the apex bank. But it's still too early for the Reserve Bank to breathe a sigh of relief, for India Inc has continued to report swelling bottom lines in the third quarter (October-December) of 2006-07 financial year.

The CII's analysis of 3,834 balance sheets show that net sales and profit after tax (PAT) soared by 21 per cent and 74 per cent respectively compared to 18 per cent and one per cent a year earlier.

The improvement in performance has been largely due to a rise in net sales due to soaring domestic consumption on the back of a booming economy. The growth in operating expenses has been slower. The net effect was reflected in the profit figures.

PAT as a ratio of net sales registered an improvement for the corporate sector from 6.4 per cent to 9.2 per cent.

The CII's analysis ratio of operating expenses to net sales shows that it declined from 83.1 per cent during October-December of 2005 to 80.5 per cent in the corresponding quarter of 2006. The report attributed this to growing competitiveness and efficiency of corporate India.

It's bit of a Catch 22 situation now. On the one hand we have corporates growing with an unquenchable thirst for profits, and on the other is the government's concern that the current boom will bring in consequences of overheating. The CII study says rising inflation and interest costs have failed to contain the cost performance of manufacturing companies. On the contrary, the manufacturing sector has been able to improve its cost performance (as a ratio of net sales) in all items of broadly defined inputs.

That brings us to the moot question: how much control should the Reserve Bank exercise? The grapevine is already expecting a tighter interest regime. The wholesale price inflation rose 6.39 per cent in the 12 months to March 24, higher than expectations of 6.29 per cent. So another rise in rates seems inevitable. Federal bond prices have already started giving up gains after the inflation data came in higher than market estimates and traders braced for a fresh bout of bond supplies.

In the next few quarters, the corporates will find it challenging to maintain their profit trend in view of the soaring interest costs and a resultant depression in demand. The CII has projected that with interest rates rising, demand contracting and exports slowing down, it is only a matter of time before the manufacturing sector comes under pressure and starts slowing down. Keeping that in mind, the Confederation has forecast a 8.5 per cent growth of gross domestic product in 2007-08 fiscal.

All eyes are set now on today's Reserve Bank meeting which will determine the correct pace at which the Indian economy needs to grow. The onus is on the RBI to arrive at the optimal rates.