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Where Are We Headed?

Monday, June 15, 2015
By Dominic Rebello

Inflation Impairs, Growth Repairs, so...

Inflation in May rose to 5.01%, up from 4.87% in April. Higher fuel-related inflation - led by an increase of Rs 7.42/litre in petrol and Rs 5.6/litre in diesel prices during the month - was behind the inflation pick-up. During May, a combination of higher global oil prices (16% higher than Mar‘15 levels) and weaker rupee (8% y-o-y) pushed up retail fuel prices. The combined fuel index (fuel & light and transport & communication) rose to 3% in May from 1.9% in April. Food inflation provided relief, falling to 5.1% from 5.4% in May. Monsoon is the biggest risk hereon, but a lot will depend on government action to keep a tab on food inflation, says Crisil adding, 'We retain our CPI inflation forecast at 5.8% for FY16, which is lower than 6% in FY15, in anticipation of pro-active steps from the government”.

Industrial production grew 4.1% in April as compared to 2.5% in March with manufacturing sub-index growth lifting up to 5.1%. Recent months’ data suggests that both consumer and investment related sectors are grinding up, albeit only gradually as indicated by the uptick in consumer and capital goods IIP sub-indices. However, the looming risk of a second consecutive weak monsoon might mean that the uptick in consumption would be slow. Crisil expects GDP growth to rise to 7.4% in FY16 with 1.5% growth in agriculture and 6.5% growth in industry. Export-oriented sectors such as textiles in manufacturing could benefit from a weakening rupee and a mild recovery in the global economy.

As regards the Implication and Outlook on the inflation front Crisil says “On the fuel inflation front, global crude oil prices have come down ($63.2/barrel average so far in June, from $64.6/barrel in May), while rupee has stabilised at Rs 63.9/$ which is the same value as in May. This suggests that retail fuel prices may not rise much further.

But on the food inflation front, there is reason to raise caution. Monsoon failure clearly remains a big risk this year. This is especially true for the northwest (NW) and central India regions where southwest rainfall deficiency in 2015 is predicted to be similar to 2014. In these regions, despite reasonably well irrigation cover, another year of weak monsoon could negatively impact the irrigation systems and crop production. Together, the NW and central regions contribute 62% to total agriculture production in India. Damage to kharif production in these two regions can flare up inflation especially in cereals (74% of all-India kharif production comes from these regions), pulses (73% of all-India kharif production) and select fruits and vegetables. In FY16 so far (April-May), inflation remains low in cereals at 2.1% compared to 8.1% last year as well as in fruits and vegetables, at 5.2% compared to 13.8% last year. But the concern is with respect to pulses where inflation is at 14.5% compared to 5.6% last year. Sowing data shows that as of June 12th, total area sown is down 8.7% yoy – that for pulses is 10.5% lower.

In case of a monsoon failure, while ample stocks of rice and wheat can be released to curb inflation, there is concern that the prices of commodities such as pulses and oilseeds - where buffer stocks are not available in the central pool, and fruits & vegetables, where extended storage is not possible - could flare up. Similarly, some dependence on imports can be sought for commodities like oilseeds where global prices have trended down. But, for pulses – where production is estimated to be 11% below target in FY15, sowing so far is lower and where inflation is already high this year – imports may not provide relief. Global pulses prices have been firming up and unless imports are subsidised by the government, could feed into domestic inflation.

The RBI has raised its CPI inflation forecast up by 20 bps to 6% for January 2016 guided by higher forecast on food inflation and inflationary effects of the service tax rate increase. Crisil however, believes that inflation will head lower to 5.8% this fiscal from 6% last fiscal based on our call that oil prices will average around $65 per barrel and rupee will stabilise at 63/$ by March 2016. Also, despite the threat of a weak monsoon, it expects the government to take proactive measures to keep a tab on food prices – the use of buffer stocks, anti-hoarding measures, lowering transportation losses and resorting to imports.

As regards the Implications and Outlook on Industrial production, Crisil is of the view that “Industrial production started the year on a positive note. Consumer durables showed some resilience in April. Green shoots in consumer demand are visible with car sales registering a growth of 12.9% on average in April and May as compared to average of 4.2% in Q4 FY15. However, the pick-up in consumer demand is still nascent with the month on month momentum remaining fragile”.

Unseasonal rains have impacted the rural economy and agricultural growth in Q4, with some ripple effects felt in April. This is reflected in falling tractor sales in the last few months, more recently registering a negative growth of 19% in April. In addition, two wheeler sales remained negative in April and May at -0.2% and -1.2% respectively. Therefore, going forward, core sector will have to buckle up first to support overall growth as the government’s focus on infrastructure spending gathers speed. Meanwhile, the successful coal auctions should push growth in the mining and power sectors.

On the brighter side, the three month moving average of the IIP series, which is much less volatile, is showing improving growth. In addition, the trend in both consumer oriented and investment oriented sectors is steadily climbing up. In addition, the uptick in the steel sub-index growth in April signals that construction activity might pick-up in Q1 FY16.

Balancing current risks, we expect GDP growth to rise to 7.4% from 7.3% in FY15, and expect agriculture growth to be 1.5% on a weak base of 0.2% in FY15. On the demand side, we expect consumption revival to be moderate, cushioned somewhat by lower inflation and interest-rate cuts. We expect industrial GDP growth to inch up to 6.5% from 6.1% last fiscal.

Crisil expects the uptick in manufacturing to be mildly supported by exports. In the beginning of FY16, the rupee has depreciated to 63.6/$ (May-end) as compared to 62.6/$ by March-end. In addition, US growth remains strong, while in the EU economic data is steadily improving. This will help in providing some cushion for export oriented manufacturing sectors such as textiles (IIP textile sub-index grew by 4.4% in April) and pharmaceuticals. In the scenario where domestic demand is expected to see only a slow recovery, this might add some relief for manufacturing production. According to the latest Industrial Outlook Survey by the RBI, 43% of respondents expect the business situation to improve, while only 7% expect it to worsen and 51% expect no change.

Rating agency Care is of the view that “ Going forward too, the industrial output is likely to: Witness further improvement with the government starting its spending on infra projects; Production of steel and cement sectors could be the beneficiaries of this increased spending. There is however the prevailing risk of sub-normal monsoons that could adversely impact and further stress rural income and thereby demand which in turn lowers demand for industrial and manufactured goods. Given the excess capacity prevailing in the manufacturing sector coupled with inability of the producers to raise prices in the absence of noticeable pick-up in demand, the improvements in industrial growth is likely to slow and gradual”.

Data Readings IIP

  • IIP grew by 4.1% in April as compared to 2.5% in March. Growth in overall IIP was supported by the manufacturing sector that grew by 5.1% versus 2.8% in March. In addition, according to use based classification, capital goods rose by 11.1% y-o-y, followed by consumer goods (3.1%), and basic goods (2.8%). Production in electricity as indicated by the IIP sub-index signalled a contraction in the sector in April (-0.2%), albeit this was partly due to a high base in the previous year.
  • The month-on-month SA growth also rose to 3.4% in April as compared to -1.0% in the previous month.
  • Manufacturing index growth revived in the month led by higher growth in food product and beverages (4.9%), wearing apparel (10.1%), wood products (16.2%), basic metals (7.3%) and machinery and equipment (20.6%). The month on month SA growth also picked up to 3.8% from -0.8% in March signalling an uptick in momentum.
  • On the other hand, in the core sector (accounting for 38% of IIP) growth remained negative for the second consecutive month (-0.4%) in April. This was as sectors such as electricity (-1.1%), cement (-2.4%), fertiliser (-0.1%), refinery (-2.9%) recorded negative growth. On the other hand, only coal and steel sub-indices signalled an expansion in volumes over the previous year.


  • Fuel inflation up, higher retail prices to blame: In May, the inflation in fuel and light segment rose to 6% from 5.5% in April, while inflation in transport and communication also stepped up. Together, inflation in fuel-related categories (fuel & light and transport & communication) jumped to 3% from 1.9%. In May, a combination of higher global oil prices (16% higher than Mar‘15 levels) and weaker rupee (8% y-o-y) pushed domestic retail fuel prices up - Rs 7.42/litre and Rs 5.6/litre in petrol and diesel prices respectively. Oil prices have since then declined, while rupee has stabilised (Figure 2).
  • Food inflation provides further respite: Food inflation declined for the 3rd consecutive month in May, falling to 5.1% from 5.4% last month. Within food, the sharpest decline in inflation came from milk and products (7.4% from 8.2%), fruits and vegetables (4.4% from 6.1%) and sugar and confectionaries (-7.3% from -6%). Among the items where inflation rose, the sharpest jump was in pulses (16.6% up from 12.4%)
  • Core inflation feels the pressure: This month, core inflation rose to 5.1% from 4.6% in April, with most of the pick-up being led by health (5.3% from 5%), transport and communication (0.6% from -1%) and personal care and effects (2.9% from 2.5%).

CPI numbers may be overstated, says SBI
Retail inflation increased marginally, as expected, to 5.01% in May’15 (SBI: 5.19%) as compared to 4.87% in Apr’15. However, the revised CPI numbers as released by the Government on February 2015 include items of unseasonal consumption (for example, tomato, cauliflower, peas and grapes that are not even included in WPI during May till July) and from that point of view may be overstated by around 25 basis points, says SBI in an Ecowrap report. According to it “If we add to this also pulses, there is an additional impact of 20 basis points. This implies trimmed CPI for May 2015 (excluding such unseasonal items and pulses) is at 4.57%, much below 5%. In fact, our CPI glide path shows that as of now, August CPI is closer to 3.5-3.6% (undershooting RBI projection at 4%), before increasing to around 5.6% -5.7% by Mar’16. Our research shows that service inflation contributed 27% of the overall decline in CPI for the 16 month period ended May’15”.

Interestingly, at State level, the story is pretty similar. The interesting point to note here is that states like Uttar Pradesh, West Bengal and Maharashtra that produce the majority of potato and onion, are witnessing inflation at record levels. Thus, ultimately food inflation boils down to controlling onion and potato prices!

IIP, on the other hand, is back with a bang and grew by 5.1% in first month of new financial year. This unexpected growth was entirely driven by manufacturing sector, which grew by 11-month high of 5.1% in Apr’15. Mining and electricity sectors, however disappointed. Consumer durable growth turning positive after 10-months of negative growth is a positive thing.

Interestingly, the Yearly SBI Composite Index of 58.2 for Apr’15 released earlier was spot on in projecting a positive trend for April (and also for May’15). SBI believes “there is indeed an element of incipient recovery with credit growth coming back slowly, particularly for working capital needs. This trend may get stronger if demand sentiments improve over the new few months on the back of an increase in consumer discretionary spending. Interestingly, service inflation has shown a large jump in May’15 to 3.8%. “This may be positive for increased consumer spending”

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