As Cash Shortage Leads To Manufacturing Contraction, Economic Shockwaves, Indian Banks Slash Interest Rates
Over 50 days after Indian Prime Minister Narenda Modi stunned India’s population when he announced on November 8 he would unexpectedly eliminate 86% of the existing currency in circulation in what was supposed to be a crackdown on the shadow economy, but instead has resulted in a significant hit to the broader, cash-based economy, overnight we noted the first official confirmation of how substantial the impact of Modi’s demonetization has been, when the Nikkei India Manufacturing Purchasing Managers Index printed at 49.6 in December, the first contraction reading since December 2015, as the war on cash crippled demand.
According to the report, output and new orders fall for first time in one year; companies reduced buying levels and payroll numbers; Input cost inflation accelerated, while charges rose at softer rate.
Commenting on the report, IHS Markit economist Pollyanna De Lima said that “having held its ground in November following the unexpected withdrawal of 500 and 1,000 bank notes from circulation, India’s manufacturing industry slid into contraction at the end of 2016. Shortages of money in the economy steered output and new orders in the wrong direction, thereby interrupting a continuous sequence of growth that had been seen throughout 2016. Cash flow issues among firms also led to reductions in purchasing activity and employment.
Looking at the upcoming timeline of cash exchanges, she noted that “with the window for exchanging notes having closed at the end of December, January data will be key in showing whether the sector will see a quick rebound.”
As Bloomberg added, other recent data also mirror the stress. Motorcycle maker Bajaj Auto Ltd.’s total sales slipped 22 percent in December, the steepest fall in at least 21 months. Motorcycle sales, a key indicator of rural demand, declined 18%. India’s biggest automaker by volume, Maruti Suzuki Ltd., reported a 4.4 percent drop in domestic December sales, the first decline in six months, while overall sales fell 1 percent from a year earlier.
A continued slowdown will strip India of its position as one of the world’s fastest-growing big economies and risk a political backlash against Modi. On Wednesday another key economic report is due, when the Service PMI data is due before focus shifts to the government’s first official growth estimate for the year through March.
India’s economy, which until recently was expected to be the world’s fastest growing, large economy, outpacing China…
… is now expected to grow 6.9% in the year through March, according to a consensus estimate. That’s well below the 7.3% predicted by a survey in November and the previous year’s 7.6% actual expansion. At this rate of deterioration, China, and its “goalseeked” 6.5% annual growth rate may soon regain the top spot among world economies.
Meanwhile, in an attempt to offset the slowing economy as a result of the Prime Minister’s unprecedented demonetization gamble, overnight Indian banks, led by market leader State Bank of India, announced sharp cuts to their lending rates after the recent surge in deposits as ordinary Indians brought their cash to the bank for “safekeeping”, raising hopes that lower borrowing costs will help spark credit growth in Asia’s third-largest economy.
On Sunday, State Bank of India, India country’s biggest lender by assets, said it had cut its so-called marginal cost of funds-based lending rates (MCLR) by 90 bps, while unveiling new products for mortgage loans, one of the fastest-growing areas. Other lenders including Punjab National Bank, Union Bank of India, Kotak Mahindra Bank and Dena Bank followed suit and also cut their lending rates by 45-90 basis points across tenures. Analysts expect more lenders to follow suit.
Banks have received 14.9 trillion rupees ($219.30 billion) in old 500, and 1,000 rupees notes from depositors since Modi’s cash overhaul. That had raised expectations banks would have room to cut lending rates, which is seen as vital to increase credit growth and spark a revival in private investments.
Cited by Reuters, Arundhati Bhattacharya, chairman of SBI, said at a news briefing on Monday, the rate cuts were intended to “jump start” credit growth and could raise it by 100-200 bps in the year ending in March. Even if accurate, it remains to be seen if such credit growth will have an offsetting impact on economic growth.
SBI now expects credit growth for 2016/17 fiscal year to be 8-9%, Bhattacharya said, still lower than the lender’s previous formal guidance of 10-12% growth. Any signs of a revival in credit could ease some of the worries from Modi’s move, which has sparked a severe cash shortage that has paralyzed parts of the economy.
The rate cuts also come after Modi on Saturday warned banks to “keep the poor, the lower middle class, and the middle class at the focus of their activities,” and to act with the “public interest” in mind.
Modi’s comments were made in a special New Year’s eve speech in which he defended his ban on higher-value cash notes and announced a slew of incentives including channeling more credit to the poor and the middle class.
Some have expressed optimism that the combined impact of banks cutting lending rates and subvention provided by the government to small businesses is likely to help turn around growth faster than expected in the next fiscal year,” said Saugata Bhattacharya, chief economist at Axis Bank, the third-biggest Indian lender. Many others remain skeptical.
For now, however, the immediate impact was on Indian Bonds, which rose after SBI’s interest cutting announcement, pushing the yield on the sovereign note due September 2026 to 6.4% from 6.51%. If anything, this is the latest sign that in a world drowning in leverage, and whose economy is priced to perfection, any ongoing “tightness” and rising rates, will only lead to adverse consequences not only in Emerging Markets, but developed ones as well.