Plumbers, carpenters & growth

Public expenditure in infrastructure, for all the talk of forthcoming investment has, by and large, remained restricted to the Golden Quadrilateral and Metro. The fact is that growth is being fuelled by internal consumption. The setting has been provided by demographics and triggered by low interest rates. The young Indian population is entering the age profile associated with optimum consumption and work. It has been in this setting that the falling cost of credit has triggered a boom through a competitive retail finance market hitherto not witnessed in India chiefly in two segments: housing and consumer durables.

For the small sector, the single biggest driver of growth has been the demand led by the housing boom. It has been estimated by a research firm that by 2010 the demand for housing might grow to 400 million units. This will necessitate a minimum outlay of $890 billion. A recent study by HUDCO found that in terms of total linkage effect with other sectors, the income multiplier of housing ranks fourth and is ahead of transport and agriculture. It is estimated that a unit increase in the final expenditure would generate additional income as high as five times.

How does housing trigger growth in the small scale sector? Except for cement and primary iron products, almost every single product and service used in the construction and finishing of a dwelling has a small sector stamp. Out of the top 200 SSI products in terms of gross output (Third SSI Census), growth of 40 product categories is directly fuelled by housing alone — for instance, paints, bricks, building hardware, wood articles, cement and concrete products, plastics, electrical products and accessories, furnishings, etc. Then take services: plumbing, painting, wiring, architectural services, interior decoration, steel fabrication, carpentry, etc.

Of RBI’s anti-inflationary moves, the most damaging for the small sector is going to be the hike in lending rates to 7.75 per cent, the highest in four years. The banks have been quick to pass on the rise to consumers by hiking their prime lending rates close to 12.75 per cent (SBI). For the small sector, the interest rates are generally in the range PLR plus 2 per cent and, therefore, we are back in the high cost finance regime of 15 per cent and beyond. This will stifle growth of the sector for three reasons.

First, the moves reduce money supply in markets at a time when the sector is suffering from an acute shortage of capital. The SSI share of net bank credit has been consistently coming down for years: from 15 per cent in 1998 to 8 per cent in 2004. In 2005-06, it hit its lowest: 6.4 per cent. Second, it affects the profitability of a small company itself. As per the studies at FISME, the incremental capital output ratio in small companies is 1:3 and one percentage increase in interest rates affects profitability by 0.33 per cent of turnover. The overall increase in interest rates during the last year is going to be in the range of 400 percentage points. This nullifies the benefit of exemption from surcharge on income tax granted to small companies in the budget.

Most important, however, the biggest impact of interest rate hike coupled with tightening of money supply will be on private consumption, particularly sectors which have been driving growth: housing and consumer durables. The rationale of the housing boom has been that the low interest rates created a situation where the EMI hovered around the monthly rent of a dwelling. It may have led to speculative investment also and may have scared policy makers but India is one of the last few countries where there is primary demand for real estate. The situation is completely different in some Asian countries, where the real estate bubble led to economic crisis. Further, households are transiting from low-income to high-income categories. The prices of consumer goods have either come down or stayed low and the low EMIs bridged the gap of aspiration and consumption. High interest rates will make EMI economics in both cases unsustainable and will stifle demand.

Nobody defends high inflation; steps need to be taken to correct it. The objection is to seemingly sole reliance on the central bank and monetary measures. This begs serious questions. In spite of high inflation, why did the central government not take steps to bring down its budget deficit and cut expenses? Why has there been hardly any concrete measure to address supply side constraints that have high weightage in the WPI and CPI? Was there no room for enticing increase in savings? After all, if savings are 30 per cent in India, in China they are 40 per cent. Why is the banking system in India allowed to be profligate on its inefficiencies, having highest margin spreads greater than 4 per cent while the international norm is less than 2 per cent? Or having deposit-lending ratio of just 61 per cent, the lowest in the world (contrast it with 130 per cent in China)? From where is the banking sector in India making money if not by lending? Are government securities or RBI rates too lucrative? How could the RBI moves address inefficiencies in economic system that demanded bold reforms, on which the central government dithered?

The central bank’s moves to squeeze money supply and hike lending rates are excessive. They might end up killing the goose that lays the golden eggs of growth, higher revenue and creation of employment.

The writer is secretary general, Federation of Indian Micro and Small & Medium Enterprises