Macro data for December is not too flattering for markets…

On January 12, post trading, the government announced the CPI (Consumer Price Inflation) for the month of December 2015 and the IIP number for the month of November 2015. For starters, the CPI, which depicts consumer inflation, has gone up by 20 basis points on expected lines. But the real negative surprise was the negative IIP number. The Index of Industrial Production (IIP) was supposed to be lower than the previous month after the sharp fall witnessed in the Core Sector growth numbers. But the extent of the fall was not anticipated. Even the most pessimistic estimates had pegged the IIP for November at a low positive number, whereas it actually came in at a negative figure. What do these statistics mean for the markets?

Inflation continues its upward trajectory…

After touching a low of 3.7% in July last year, inflation has been on an uptrend. In fact, for the month of December 2015, CPI inflation has come in at 5.61%, 20 bps higher than the November figure of 5.41%. The base effect was supposed to go away after September but the sharp impact was not anticipated. The RBI had targeted keeping inflation at below 6% by March 2017 and at the current rate of growth that looks difficult. It is important because it also discourages the RBI to cut rates and the industry is looking forward to at least two rate cuts of 50 basis points in this calendar year.

It is instructive to understand what exactly drove inflation in the month of December. No prizes for guessing, but the culprit was once again food inflation that rose to 6.4%, almost 33 basis points higher than the previous month. On a Y-O-Y basis, food inflation is sharply higher from 3.96% in December 2014. Both in case of food inflation and overall inflation, the rural inflation has risen much more sharply compared to the urban inflation. Ironically, in case of food inflation, the urban food inflation has fallen, while the rural food inflation has gone up sharply.

Food inflation is critical for three reasons in India. Firstly, food inflation accounts for nearly 46% of CPI inflation and hence it has the tendency to decide the direction and trajectory of consumer inflation. Secondly, food inflation by default tends to be sticky. That means it takes time to come down once it has gone up. Thirdly, food inflation is very susceptible to supply side shocks like poor monsoon, drought conditions, poor infrastructure etc. These supply shocks are dangerous as the government of the day is not in a position to control these supply side factors. Within the food basket, the sharpest rise in inflation has occurred in Pulses and related products where the annual inflation is nearly 45%.

CPI inflation, and especially food inflation, will be closely watched as it will decide the trajectory of the RBI view on interest rates.

IIP had a nasty fall in November 2014…

The signals of a slowing IIP were always there when the core sector showed a contraction for the month of November 2015. After touching a high of 9.3% in October 2015 the IIP growth fell sharply to -3.2% in November 2015, compared to the corresponding period in November 2014. The warning signals were always there when the core sector growth numbers were announced. The major question is what does this lean IIP number imply for the corporate profitability growth and for the overall GDP growth in India? Remember, India’s corporate profits ex-oil have been in negative territory for the last 5 quarters and the GDP growth for the current fiscal has already been scaled down from 8% to a more reasonable range of 7-7.5%.

For the month of November, mining grew at 2.3%, while electricity grew by a marginal 0.7%. The real reason for the fall in IIP was the manufacturing sector which saw a -4.4% contraction. In fact within the 22 sectors that are considered under the Manufacturing Sector, 17 sectors showed a negative growth. In terms of use-based classification, what is worrying is that the biggest de-growth came from the capital goods sector with a -24.4% fall. This is bad news for companies that are betting on a revival in the capital goods sector. In terms of products, the major positive contribution came from gems & jewellery, sugar, minerals, telephone instruments and pipes. The major negative contributions came from insulated cables, aluminium, passenger cars, alloy steel, stainless steel, HR coils and insulated rubber.

Both the data points announced today are critical inputs for markets. The CPI is critical because it becomes a very important input when it comes to the RBI decision on repo rates. The RBI governor has always expressed concerns about sticky food inflation and that is coming back to haunt the Indian economy. Another bout of rise in food inflation will mean that Indian industry will have to forget about rate cuts for the time being. Secondly, IIP number is critical as it is an important indicator of the GDP growth and the revival in corporate profits. The government surely needs to plan a big bang to rectify both these parameters.

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