Inflation in check but industrial growth continues to disappoint…

The government of India recently announced the data on price inflation and IIP growth. While the Consumer Price Inflation (CPI) number for the month of February was encouraging with the fall in food inflation, the IIP January number continued to disappoint as it went deeper into negative territory compared to the previous month. In case of IIP, the indications of a slowdown were already there from the core sector numbers, but a slowdown in IIP has implications for overall GDP growth.

Why the CPI numbers were encouraging…

The CPI becomes one of the most critical inputs for the policy makers as it signals the direction of retail consumer inflation. For the month of February 2016, the CPI inflation came in substantially lower at 5.18% compared to 5.69% in January. This sharp fall in inflation can be explained partly by the base effect, which normally shifts favourably around the Feb-March period. The sharpest fall came in on the food inflation front which fell sharply from 6.85% to 5.30%. The only worry is that the rural inflation has not fallen to the extent of urban inflation. Within the food basket, the inflation contribution of pulses continues to be high at 38%, although this number has fallen sharply in the last 2 months. Inflation in cereals, milk products and vegetables were lower than the average while fruits actually displayed negative inflation in February. Overall, the picture seems to be encouraging on the consumer inflation front. There were worries when the inflation had touched 5.69% in January, but if this trend continues then inflation may not be a big worry. However, one still needs to examine if the effect of OROP and the 7CPC on retail inflation. This will be visible after a lag of one quarter.

But IIP numbers were below expectations…

The IIP for the month of January came in at -1.5%, which is worse than the -1.2% recorded in December last year. What is more worrying is that the total IIP growth for the first 10 months of this fiscal has been just around 2.7%, which could have negative repercussions for the overall GDP growth forecast. Manufacturing continued to be the segment to disappoint the most. While mining grew by 1.2%, manufacturing witnessed a -2.8% de-growth in IIP. The redeeming feature was electricity which saw a healthy 6.6% growth compared to the corresponding period last year. The user classification has some interesting pointers. It is the capital goods use that is the worst affected with a -20.4% contribution to the IIP. This is a signal that the capital goods cycle is still far from turning around and could have negative repercussions for the capital goods shares in the market. Within the overall IIP basket, products that showed high negative growth include; Rubber insulated cables, aluminium foil, polythene bags, antibiotics and boilers. The products that showed positive growth in IIP include wood furniture, ship building & repair, polypropylene, paraxylene and telephone instruments. Overall, the manufacturing IIP of core and basic industries continues to disappoint.

What does this mean for the RBI rate trajectory?

The most important question that we need to ask is what does this combination of CPI and IIP data mean for the RBI rate stance. Here are a few key pointers from the latest macro data on inflation and IIP:

  • The fall in inflation to 5.18% brings the inflation well within the target of 6% set by the government as the outer limit. Even the RBI has been reluctant to cut rates when inflation is above 5.5%, as we saw during the last 2 policy statements.
  • The more encouraging take-away is that food inflation has fallen substantially. That has been a key irritant for the RBI as food inflation tends to be sticky due to its dependence on monsoons and poor distribution infrastructure.
  • The CPI number, therefore, gives a strong justification for the RBI to cut repo rates.
  • The IIP number going down to -1.5% is another reason for the RBI to prop up industrial financing through lower rates. With the NPA problem being addressed separately and the government getting closer to helping the banks recapitalize, the transmissions of rate cuts should also become seamless.
  • More importantly, since the budget has also focused on fiscal responsibility, the threat to inflation from fiscal slippages does not exist any longer.
  • The combination of lower CPI inflation and low IIP makes a strong base case for the RBI to cut rates when it meets next on April 05 for the Monetary Review. Whether it turns out to be a 25 bps cut or a 50 bps cut would be more a function of the FOMC rate trajectory.

In a nutshell, the good news may be that the RBI may really have a strong case for cutting rates. That has generally been positive for the economy in general and the markets in particular.

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