Overview: Retail inflation edged down to 8.3% in May from 8.6% in the previous month as both food and core inflation fell. In the short run, a strong base effect from last year is likely to pull down the June inflation figure further.
Meanwhile, data for April suggests that industrial activity is beginning to pick up. Industrial production grew by 3.4% in the first month of FY15, its fastest growth in 13 months. Sustaining momentum in industrial production, however, will depend on the government’s resolve to fast track stalled projects, revive investment pipeline and lift consumption demand by improving growth prospects. Our FY15 industry GDP forecast of 4% (compared to 0.4% in FY14) also hinges on a healthy monsoon, which is now at a glaring risk. Deficient monsoons could slice around half a percentage off industrial growth.
CPI Inflation edges down with declining food inflation
CPI inflation fell to 8.3% in May from 8.6% in the previous month (Figure 1). This was driven by a fall in food inflation to 9.3% year-on-year (y-o-y) from 9.6% in the previous three months. Inflation fell in cereals to 8.8% in May (cereals accounts for 30% of food basket) and condiments and spices and vegetables, while it rose slightly in pulses, oil and fats and fruits.
CPI Core inflation (excluding food and fuel & light) fell to 7.8 % y-o-y in May from 7.9% in April. This fall came despite a low base from last year, signalling that downward momentum in the core is building up. In the core, housing inflation fell to 9.2% from 9.7% in the previous month.
The recent fall in inflation is in line with the RBI’s quarterly inflation expectation survey released on June 11. This survey carried out during January-March 2014 signals that inflation expectations are moderating. The survey results showed that for the first time, inflation expectations for three months ahead dropped below the current inflation perception (Figure 2). The year ahead expectations also fell with 60% of the respondents expecting prices to rise above the current rate as compared to 77% respondents in the second quarter FY14.
The RBI has increased interest rates by 75 basis points since September 2013 and this has helped to anchor inflation expectations. Lowered expectations will feed into actual prices, putting downward pressure on inflation in the coming months. In its recent monetary policy meeting the RBI also adopted a slightly dovish tone, indicating that faster than expected fall in inflation could provide room for monetary easing.
However, an upside risk to inflation remains from the potential failure of monsoons. The IMD indicated that the probability of deficient monsoon (< 90% of long period average) is 33% and sub-normal monsoon (90-96% rainfall of LPA) is now 38%. In addition, it raised the possibility of an El Niño in 2014 to 70%. A weak monsoon could push up CPI inflation with the weight of agriculture-related articles accounting for 50% of the CPI. In this scenario, food inflation may rise during Q3 FY15, and some upward pressure on prices might be visible in anticipation of this rise and hoarding activity in the coming months.
IIP: Industrial output jumps 3.4% in April
Industrial activity surged in April as output grew 3.4%, the highest growth rate in 13 months. The pick-up was mainly led by an uptick in industrial demand and investment-led manufacturing sectors, higher electricity production and a rise in mining output.
Highlights of April IIP data
- Manufacturing sector turned around in April, with output growing 2.6% possibly reflecting some uptick in the domestic investment scenario;13 out of 22 manufacturing industries recorded positive growth in April (compared to 11 in March). Of these 5 are producers of industrial and investment goods, and have 22% weight in the manufacturing index. These include basic metals, metal products, machinery equipment and transport equipment where output grew in the range of 7 to 10%. Electrical machinery and equipment sector was an outlier growing at 66% on a year-on-year basis.
- Electrical machinery and equipment sector also saw high growth (14.5%) in FY14.Huge capacity additions of nearly 38 GW in the power sector during the past 2 years coupled with strong capacity addition to transmission lines have resulted in a rapid increase in demand for electrical machinery. In FY15 too, proposed capacity additions of another 17 GW in the power sector and concomitant investments in transmission lines and substations by Power Grid Corporation of India Limited (PGCIL) could continue to push output growth in the electrical machinery and equipment sector.
- The capital goods sector mirrored the uptick in industrial and investment goods output, as the sector grew 15.7% in April. Consumer goods sector continued to face the brunt of weak consumption demand as output fell 5.1% led by a 7.6% fall in consumer durables’ output.
In the last two years, economic activity has expanded at its slowest pace in the last two decades. And, in fact, in FY14, if not for above trend agriculture growth, overall GDP growth would have been only 4.3% – lower than FY13 GDP growth of 4.5%. Our FY15 industry GDP forecast of 4% (compared to 0.4% in FY14) critically hinges on a healthy monsoon, which is now at glaring risk. If monsoons are to weaken, it could directly slice half a percentage point off industrial growth. The other supporting factor for industry this year, in addition to improved mining activity will be the spillover impact of projects which started getting clearances last year and are expected to hit ground this year.
However, the better-than-expected election outcome with a strong political majority for the government has raised industrial outlook beyond FY15 in several ways. For one, investor sentiments have already begun to improve as is visible in the surge in foreign investor inflows into Indian equity and debt markets. For domestic investments to revive, however, some long pending structural bottlenecks to infrastructure and manufacturing growth will have to be addressed. The government has initiated some difficult yet crucial reforms such as making labour market flexible, easing of FDI norms especially in sectors that create jobs and assets, and is keen to further unblock stalled investments in power, road and rail projects as well as promote labour-intensive manufacturing. Overtime adoption of key reforms like goods and services tax (GST), sustained pruning of fiscal deficit to make way for productive spending and battling the issue of rising bad loans among others will hold key to improve the prospects of the Indian economy.
Vidya Mahambare is the principal economist; Dipti Deshpande senior economist and Sakshi Gupta junior economist with CRISIL Research.