India - Now the real sector

T N Ninan

It may sound crazy to say this when stock markets have crashed through another floor, but the primary problem today is not the financial but the real sector. Many of the financial sector’s issues have been dealt with. For instance, the average price-earning multiple for all Sensex stocks is still above 11, which is comparable to what prevailed in 2002-03 and therefore not out of line in a downturn. In the currency market, the dollar is Rs 50, but we are into the last burst of selling by foreign institutional investors. Once that pressure point eases, the rupee could become more stable and (though it looks like a long shot) the stock market should recover some of its bearings.

As for the money market, the stressed sectors face a problem but the overall flow of credit is a healthy 29 per cent. Interest rates are high, but since call rates have fallen and general lending rates have not, the issue in bankers’ minds is credit risk and not the supply of money—which supports the thesis that the real sector is the main problem. Besides, with Parliament approving overdue payments to fertiliser and oil companies, and with September tax money finding its way back into the system, the liquidity situation should continue to ease. Specific steps are needed to ease pressures on the mutual fund and NBFC players, but even in the case of the latter, the issue could be the credit-worthiness of borrowers.

The danger, therefore, is not so much a further financial meltdown (here’s hoping that value buyers will emerge on the stock market before long), but the severity of a cyclical downturn. The corporate results for the July-September quarter point to this, with 40 per cent of companies reporting an absolute drop in profits or a straight loss. But even as the Q2 results announced so far show that net profits have dipped from 15 per cent of net sales in Q2 of 2007-08 to about 12 per cent, that is not an unhealthy level for the system as a whole and may in fact be high by Indian historical standards. The issue therefore relates to the specific problems of the toxic sectors.

At one level, the reversal of the commodity price boom has hit a great many companies—Tata Steel, Hindalco and the like—but prices are still high by historical standards. The surfeit of retail credit has tested the limits of people’s ability to pay monthly loan instalments, so credit-driven sectors like automobiles face a demand slowdown, while housing is additionally impacted by the slow imploding of the price bubble. Real estate players will have a rough ride, as the price for having risked a dramatic increase in their borrowing levels. Capital goods face a drop in fresh orders because enough capacity has been created in many sectors and the government is unable to up its spending on physical infrastructure (because so much money has gone into subsidies). Aviation had over-extended, and needs to downsize. Many of these are necessary correctives to the problem of over-reach that happens in a bull market, and will be painful, but should be recognised as correctives. Exports will of course be affected by the global slowdown.

That being the story at this point, the policymakers’ attention has to be focused on steps to minimise the downturn. One answer is cheaper credit, especially since inflation has more or less disappeared as a worry point, so the Reserve Bank missed a trick yesterday. But good macro-economic management (fiscal control, followed by spending on infrastructure) is even more important. A combination of the two could lift spirits sufficiently to facilitate a recovery.