Is India heading for a slowdown?

Nobody in the world thinks that India’s trillion-dollar economy is headed for a slowdown. The projections made in the month of March and April 2007, even after higher interest rates by various national and international agencies put the growth in GDP in the range of 7.6-9.3%

The impact of high interest cost on large corporates of India is insignificant. Though there is some increase in the average cost of borrowings, the ratio of Interest to sales, which measures the impact of borrowings to expand the scale of operation, is insignificant. For almost all Sensex companies the ratio remains in the range of 1-2%

Rising interest rates do two things to the consumers; they slow down the demand and also increase delinquencies. The first effect is beginning to be felt. Two major consumer financiers ICICI Bank and HDFC report slowdown in credit growth from 30% to 25% in past year and project credit growth to be 20% in 2007-08. Other categories of retail lending, like two-wheeler, car loans and consumer durables may face the heat due to their demand being more price-sensitive. However, the mortgage-based consumption in India is only 2% of GDP compared to similar figure of 50% in US and 15-20% in South East Asia. Hence, the impact of high interest rate on consumption and thereby on GDP is limited in India.

Falling interest rates have been considered as the biggest trigger to push investors to the equity investments vis-à-vis the debt investments. Will the converse be true? It is true that rising interest rates on bank deposits offer investors a risk-free earning avenue and over the last year, large number of investors has been attracted towards it. The deposit growth over the past year has been phenomenal 23% and RBI expects it to grow further.

When the investors re-do their calculation, dividend being tax-free and long-term tax on capital gains being only 10%, the investors are sure to realize that the return on equity investments would be far higher than the taxable 9% return on bank deposits. We are quite sure that investors in India are pretty savvy to calculate their total returns and make intelligent choice.

When the interest rates are rising, the first reaction of everyone is to predict a slowdown in the economy. It is too simplistic to project lower corporate profits in wake of higher cost of funds. However, a closer look at the reality shows that things are not as bad as they may seem. There is lot more spirit and spontaneity in the Indian economy which is not going to be bogged down by the higher cost of funds. India Inc. has large number of options to finance its growing appetite for growth. The ratio of interest to sales, which measures the impact of borrowings to expand the scale of operation, is insignificant for Sensex companies.

If consumption and investment that accounts for more than 80% of the GDP are not getting much affected, how on earth the interest rates would cause a slowdown in the economy?

Original Author: Unknown