Inflation heads lower but IIP continues to disappoint…

The consumer inflation (CPI) and the industrial growth (IIP) data announced by the Central Statistical Organization on 12th September brought in mixed indicators. While inflation was sharply lower for the month of August, the industrial production figure for July fell back into negative territory. The CPI and IIP data become critical as it is the last data announcement before the next RBI monetary policy on October 04th. Hence this data is likely to have a significant bearing on the RBI stance on repo rates. But first, an analysis of the economic reality behind the CPI and the IIP numbers…

Fall in inflation driven by food inflation…

CPI inflation for the month of August 2016 came in 102 bps lower at 5.05% compared to a rather uncomfortable 6.07% in the month of July 2016. This also positions the inflation number more favourably with the government long term target of 4% by next year. Over the last 4 months, the CPI number had been consistently rising on the back of harder food inflation. Two things seem to have worked in favour of lower inflation in the month of August. Firstly, the base effect which comes into play in the second half of the year seems to have played a part in taming retail inflation. Secondly, the better than expected monsoon (just about 4% below LTA) was also responsible in bringing down food prices.

The fall in inflation was largely driven by a fall in food inflation, which fell from a high of 8.35% in July to 5.91% in August. There has been a sharp fall in rural inflation and urban inflation during the month. Within the food basket, there are 2 areas of concern. Firstly, the pulses inflation at 22% is sharply lower than previous months but still needs to be kept under check. This is because, India is the major producer of pulses and hence imports cannot be used to bridge any supply deficit. Hence pulse inflation tends to be the most complicated. Secondly, sugar inflation has shot up to 24% but with the government taking immediate steps like curtailing futures trading in sugar and reducing producer stocks, this situation is likely to ease in the coming months. Overall, food inflation has given the CPI number a lot cheer about.

But, IIP continues to be a tad disappointing…

The index of industrial production (IIP) for July 2016 came in at (-2.4%) which is sharply lower than the (-0.4%) reported in July last year. This negative growth in IIP is also disappointing because we had seen consistently positive IIP for the last few months. Overall, mining and electricity recorded growth of 0.8% and 1.6% respectively while manufacturing recorded (-3.4%) growth and was responsible for the negative IIP for July. Within the industry groups, 12 out of the 20 industrial groups have shown negative growth. Some of the industry groups that have shown negative growth include electrical machinery, medical equipment, watches and apparel. Ironically, the positive growth has come from sectors like tobacco products, refined petroleum products and nuclear fuel.

What is, probably, more suggestive is the use-based classification of growth rates. One often wonders why the IIP continues to be depressed even as the Core Sector growth (which constitutes 38% of IIP) continues to grow impressively. The answer lies in the manufacturing sector, specifically the capital goods space. A revival in the capital goods space will be indicative of a revival in the capital cycle. But for the month of July 2016, the growth in capital goods has come in at (-29.6%), which has contributed substantially to the lower IIP figure.

Good news could be that rate cut could happen sooner…

That brings back to the central question; what do these numbers mean RBI action on repo rates. After a long time we have a situation where both the CPI data and the IIP data appear to favour a rate cut. While one swallow does not make a summer, if CPI continues to remain subdued for a couple of more months the RBI may be induced to front-end rate cuts. The lower IIP also makes a strong case for a rate cut, although as the previous governor had pointed out transmission would be the key. So what exactly could the RBI do as an outcome of this data?

Firstly, the RBI may be averse to cut rates in October as the US Fed has already been talking hawkish and looks prepared to hike Fed rates by end of the year. Also, the RBI would prefer to watch the inflation and growth data for a couple of months. A rate cut in December looks a lot more likely, but that would still mean that rate cuts would get front-ended from the last quarter. Secondly, the RBI may consider being a little more aggressive on rate cuts around December as the pressure of FCNR(B) redemptions will also be completed by November. Hence the RBI may even contemplate 2 rate cuts instead of just 1 rate cut in this fiscal year. That may be the real good news for markets!

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