Business conditions remain strong in certain basic industries such as coal, oil, steel, and machinery, but shortages are still hampering output. Some firms are coping with inflation by increasing the use of escalator clauses. Inflation is contributing to some hoarding and speculation in inventories. Recent strength in business loan demand largely reflects the need to finance higher-valued inventories and rising accounts receivable at a time when real cash flow is deteriorating.

According to our directors, materials shortages continue to constitute a major problem. One machine tool executive reported that nondelivery of vital components has slowed the entire production process. A director from a large business machines firm, however, said that the raw materials situation is improving. Another director indicated that basic materials industries are going to expand capacity significantly (until now, pollution control expenditures have absorbed a high percentage of their capital equipment spending.) One director noted there is no longer an oversupply of large cars, in fact, it appears that the auto companies may have over-reacted in their shift to small car production. Demand in the coal industry is so intense that, according to one director, "coal at $35 a ton includes logs, bone, slag...anything." A banker reflected that coal machines, which formerly would have been financed over 5 years, are now financed over 2 years. One banker was concerned over increased personal loan delinquencies and the alarming moves of some individuals to consolidate loans and then take our new lines of credit. Consumers appear to be maintaining a high level of spending according to one of our directors associated with a major retail chain.

A number of large industrial firms in the District were questioned on recent developments in pricing policies, working capital positions, inventory situations, and capital spending plans. The responses suggest an increased use of escalator clauses in long-term contracts for products bought and sold. Indexing (in one form or another) is also increasingly common in contracts and orders involving long lead-time items. The steel industry continues to quote prices at time of delivery rather than at time of booking. A major coal producer said that since last month coal prices have been quoted at time of shipment with all cost increases based on an escalator clause. In addition the firm recently wrote several long-term contracts calling for upward price adjustments whenever the rate of return on investment falls below the rate specified in the contract. Liquidity positions are mixed. Some businesses report ample cash positions (steel, oil, coal, chemicals, nondurable consumer goods). They have been net suppliers of funds to the commercial paper and CD markets. Firms in the machinery, tire and packaging industries have been borrowing heavily from banks and the commercial paper market to finance inventories and accounts receivable. Virtually all firms report increasing receivables, which they say is typical during periods of tight money and rising prices. Several machinery companies commented on a general tendency for their customers to delay paying bills as long as possible. One major oil company by contrast has reduced its receivables and improved its liquidity position by withdrawing about 2.5 million credit cards since September, thus forcing its customers to pay cash. In turn the firm is required to make immediate payment to the Arab countries for purchases of crude.

Firms contacted generally want to build their stocks-mainly to protect current production and sales schedules but in some instances as a hedge against price increases. Steel producers would like to rebuild depleted stocks but find it impossible because of strong customer demand. Some of the steel inventory accumulation by customers has been price-hedging according to the steel mills. Steel producers are also desperately in need of coal supplies. Oil companies have been unsuccessful in trying to build stocks. Machinery companies report inventories must be built before production can be increased. Shipments are being held up for lack of materials and component parts. Shortages of raw materials have also prevented chemical and packaging firms from increasing their inventories as much as they would like. Several firms however pointed to the growing risks of speculating on certain price volatile raw materials.

Capital spending plans are not being altered as a result of current financial or economic conditions. Several firms mentioned that shortages of materials could possibly result in their spending being stretched out. As a general matter, firms intend to finance fixed capital investment from external sources of funds. One steel company with large spending plans said it would be reluctant to borrow now. They will first liquidate some of their marketable securities and use reserves set aside for capital programs before resorting to external financing at current interest rates. A rubber-chemicals producer said high interest rates might adversely affect spending plans for the tire industry, but borrowing costs are easily recovered for investment in chemicals and plastic goods because of higher returns.

The increase in business loans by District banks continues to be strong, although at a slightly reduced pace from March. Bankers indicated that loan demand involves, in large part, takedown of lines-of-credit to finance inventories and increasing accounts receivable. The commercial paper rate differential and delay in going to capital markets also help to explain the strength in business loan demand. A number of bankers, however, report that some loans are not being repaid at stated maturity. Corporations are caught in a cost squeeze due to the underestimation of increased costs. Bankers report a decrease in foreign commercial bank lending and some slowdown in loans to nonbank financial institutions. As a general matter, banks are being conservative and selective in accommodating loan demand by REITs.

There seems to be mixed opinion on prospects for bank credit. Some of the bankers contacted see little letup in business loan demand because businesses will increasingly feel a liquidity squeeze. Also, they expect continued heavy demand for financing capital programs. On the other hand, a few expect a letup in bank credit as the spread between the commercial paper rate and the prime rate narrows.