The Hindu : Business : Price control through the back door?

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Monday, Aug 30, 2004

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Price control through the back door?

Inflation continues to be in the news. The Government has been doing its bit — forcing steel prices down and moderating oil prices earlier. But very difficult to understand has been the contrarian stance of some important banks.

AFTER LOWERING the duties on petroleum products the Government went ahead with the next item on its anti-inflation agenda. This time the focus was on steel, a commodity currently in great demand in India and abroad and whose price rise has contributed to the high inflation. The strategy has involved a lowering of customs duty on non-alloy steel, on old ships brought to India for being broken up (a major source of input for the industry) and on certain types of melting scrap.

The duty reductions on steel are estimated to cost the exchequer Rs. 305 crores this year over and above the Rs. 2,500 crores attributed to the cuts in petroleum duties. The idea clearly is to influence steel producers to lower their prices. Imports of specific steel products will become cheaper. Certain inputs that go into steel making such as scrap will be more freely available and at lesser cost following the duty reduction. However, industry sources feel that because internationally steel prices are ruling firm duty reductions of the type attempted will not matter. Imported steel will not be cheaper and hence will not help much in arresting domestic inflation.

Steel prices outside India were higher by about $70 a tonne compared to domestic prices and even after duty reductions a substantial gap (in the region of Rs. 1,500-2,000) will remain. So until international prices tumble down there will not be any serious competition to domestic producers from imports. Which also means that prices in India need not be brought down. The Government however did not stop with what were perceived to be symbolic gestures. Where fiscal measures failed, persuasive tactics worked.

Tata Steel led the pack with a sharp reduction in price of Rs. 2,000 a tonne for its products. SAIL, Essar Steel, Jindal Vijaynagar and Ispat Industries followed suit, although the quantum of their reductions was less. Inevitably questions have been asked: did these companies succumb to government pressure and reduced prices when there was no commercial reason to do so? The highly cyclical steel industry is now in a boom period. Just three years ago, it was passing through difficult times. Many manufacturers were in deep trouble and no new investments were made.

The developments in the steel industry mirror an old dilemma. Even conceding that organised industry has a role to play in securing broad economic goals (such as price stability) should the Government dictate its action? Is some form of price control being brought in through the backdoor? Such questions will continue to be relevant even if the steel price cuts help in bringing about general price stability.

Wrong signals

Three weeks ago, in the wake of the news of surging inflation, the country's largest bank, State Bank of India, sent out a contrary signal by reducing its short-term fixed deposit rates. In the normal course the response in such a situation would have been to hike interest rates.

The bond markets had already reacted anticipating an interest rate hike: as their yields moved up their prices crashed. Indeed, SBI which, along with other banks had made plenty of money from its treasury operations in a falling interest rate regime, badly caught on the wrong foot .It is expected to report a loss for the second quarter. Yet in one of its core activities the bank's management chose to be contrarian, never mind that almost all its depositors have already been earning a negative return.

Various explanations have been given. After the Global Trust Bank fiasco many investors flocked to the safety of public sector banks, many of which like SBI were already flush with depositors' money. The inference is that banks can discourage deposit flows, by pushing down their rates.

Other `commercial' explanations are also possible. Banks no longer earn much through their traditional function of lending. Their rates for loans to prime borrowers are way below their prime lending rates. There is not much scope for hiking interest rates which a textbook approach to inflation would require. Basically, therefore, SBI is protecting its interest spreads by lowering the deposit rates. That of course is highly retrograde for its depositors, many of whom have nowhere else to go.

If banks give their depositors a negative return, chances are that many desperate individuals will take unacceptable risks just to make both ends meet. That was the message last time when normally risk averse people flocked to NBFCs, partnerships, sole traders and nidhi companies that promised sky high returns.

There could be another, less flattering, explanation for SBI's apparently illogical stance of lowering its deposit rates at a time of resurgent inflation. It might be a coincidence but when SBI surprised everyone with a deposit rate cut, government spokespersons were either denying the consequences of inflation or downplaying it. Maybe SBI took upon itself the task of reinforcing the (then) official message!

An interpretation along these lines is well within the realm of probability. (After all, SBI has been known to take decisions to please the Government. Remember the Resurgent India Bonds? Did it matter that the RIB exercise was extremely costly for the bank and its shareholders?)

C. R. L. Narasimhan

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