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Inflation cheers, IIP disappoints, but... There Are Reasons To Cheer

Monday, September 15, 2014
By Deepak Sahijwala

While inflation headed down, industrial growth tumbled to 0.5% in July compared to an upwardly revised 3.9% growth in June. Slower growth was led by a fall in capital goods output and a continued decline in consumer goods output (y-o-y). However, higher growth in capital goods output is likely to resume next month due to a low base from last year. Going forward, domestic demand is expected to strengthen as suggested by recent surveys on industrial outlook and consumer confidence. For FY15, Crisil Research forecasts  GDP  to grow by 5.5%, with industrial growth expected to rise to 3.6% from 0.4% in FY14. A more optimistic  Moody’s expects growth to approach a 6% pace by year's end. So the present disappointment may just be short-lived...

CPI inflation fell to 7.8% in August from 8% last month as a sharp decline in core inflation (inflation excluding food and fuel) more than offset a marginal pick-up in food inflation. For the first time since January 2012, core CPI inflation fell below the 7.0% mark to 6.8% y-o-y in August. The seasonally adjusted month-on-month momentum in the core also fell to 0.3% in August from 0.6% last month.

The fall in core inflation was driven by an over 1 percentage point decline in inflation in 2 categories; transport & communication and household requisites. Both of these categories, (together having a weight of 30% in the core CPI index) favourably benefited from a very strong base effect from August last year. Excluding these two, core CPI inflation was almost unchanged from last month at 7.7%. A significant decline in petrol prices (Rs 5.4 per litre since July in Mumbai) due to lower crude oil prices globally, is also likely to have contributed to the downward price pressures in transport & communication. “We expect this to continue going forward as no further hike in diesel prices is expected as long as crude oil prices stay at current levels. The under recovery in diesel has fallen to 8 paise per litre after the August 31 hike” believes Crisil.

In the case of food articles, price pressures were seen building up in pulses, condiments & spices and milk & milk products. Inflation in each of these categories has been rising for the last 3 months. Inflation in pulses in fact rose by 1.1 percentage points to 6.9% y-o-y in August, and needs to be watched closely as the crop has been impacted by weak monsoons this year.

According to the CRISIL Deficient Rainfall Impact Parameter (DRIP) – which captures both the magnitude of the rainfall shock (measured as the deficiency of rainfall) as well as the vulnerability of a region (measured as a percentage of un-irrigated area) – pulses and coarse cereals are likely to have suffered some damage due to the late onset of monsoons coupled with heavy rains in certain parts of the country this year.

The DRIP scores for pulses and coarse cereals this year are similar to (or slightly worse) 2012 when inflation in these categories had surged to over 13-14% in the second half of the year. This year, given the steps taken by the government, we do not expect a similar surge in prices but any build of price
pressures needs to be monitored closely. The government has already offered a line of credit to states to import pulses to compensate for domestic supply shortage and keep prices in check. In the case of cereals fortunately, the affected crops, namely jowar, bajra have a low weight (2.4% together) in the CPI food basket.

Going ahead, says Crisil “From next month onwards, food inflation is likely to taper off as a favourable base effect from last year kicks in - food inflation had surged to an average 13% during September-December 2013 due to a supply-side shock to vegetable prices. Moreover, low increase (3-4%) in minimum support prices of rice and wheat and the offloading of excess stocks will also help keep a check on food inflation. Food grain stocks in the central pool are currently at 17.3 million (mn) tonnes for rice and 35.5 mn tonnes for wheat – both of which are 2.5 times the quantity mandated by buffer norms and strategic reserve requirements.

However, as a result of weak monsoons and its perceived impact on food prices, household inflation expectations have risen. This is reflected in the RBI’s quarterly survey, where the three-month ahead inflation expectations rose in September quarter after declining for the previous 2 quarters. Rising demand with a gradual recovery in GDP growth and rising inflation expectations may create an upside risk for core inflation in the coming months.

Even if crude oil prices stay low, once the favourable base effect wears off in January, there is a possibility of headline CPI inflation rising slightly above 8% toward the end of the fiscal year. This means that there is no room for a rate cut in FY15.”

As regards IIP growth; it fell to 0.5% in July compared to an upwardly revised 3.9% growth in June and an average 4.2% growth in Q1. Manufacturing output fell by 1% in July compared to 2.5% growth in June. Bulk of the slowdown came from the capital goods sector, where the output fell 3.8% due to a high base of last year. The capital goods index had jumped 23% m-o- in July 2013 due to a spike in the electrical machinery and apparatus sector, but had fallen by nearly 10% in the following month. However, even after excluding this sector, the rest of the manufacturing sector growth was still 0.6% lower y-o-y in July. Meanwhile, growth in the core infrastructure segment too is yet to gain momentum - growth fell to 2.7% in July compared to 7.3% in June.

Crisil believes  that 'Incremental policy measures and bureaucratic improvements that the new government has taken in its first 100 days to improve the ease of doing business, has had a positive impact on business sentiments. However, it will take some time for these to translate into growth. While these are critical to lift growth in the short-term, the government needs to move forward with structural policy reforms such as implementation of GST, easing labour laws, rationalisation of fiscal subsidies, and amendment of land acquisition norms, to maintain the growth momentum beyond this year”.

Growth To Approach A 6% Pace By Year’s End, Says Moody’s
India's economy has improved in recent months, though for cyclical reasons unrelated to the new government. Downside risks around inflation, the external and fiscal deficits, and volatile financial markets have all receded, helping restore confidence and drive a slow but definite upturn. GDP grew 5.7% in the June quarter after hovering at 5% for the previous two years, and Moody’s Analytics expect growth to approach a 6% pace by year's end.

In a report by Glenn Levine and the Asia Pacific Staff of Moody’s Analytics, the rating agency says “India still has an inflation problem, however. Wholesale prices have cooled, but the central bank is paying greater attention to the consumer price measure, which remains elevated at 7.2% year over year in July. It is increasingly likely that the RBI will not cut interest rates this year. Governor Rajan made lowering inflation the bank's main priority, and it will be difficult to justify a rate cut unless CPI inflation falls comfortably below 6%. Yet the economy’s output gap is closing and the current monsoon season, while not as poor as initially feared, could still be 10% below average, cutting crop yields and pushing up prices from early 2015.”

According to it “The pieces are in place for Prime Minister Narendra Modi to be an influential leader and lift the economy’s growth pace. Reforms have come slowly, in part because this is Modi’s first stint in the national parliament and until recently he didn’t know the exact size of his majority. His challenge will be to continue and accelerate the pace, while trying to keep parliament on his side. It is a difficult task, but if Modi achieves it he could lift India’s long term GDP growth, which is the surest way to lift millions out of poverty.”

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