The data on industrial production, despite its volatility, seem to suggest the growth-inflation dynamic has reached a critical point from where a rate cut is inevitable. The index of industrial production (IIP) expanded 4.1 per cent year-on-year in February and 2.4 per cent month-on-month in seasonally-adjusted terms. However, the January figure was revised to 1.1 per cent, from 6.8 per cent reported earlier. According to Deutsche Bank: “After this revision, the three-month moving average outturn of factory output fell to 2.6 per cent in February, from 3.2 per cent in January. But note that even on a three-month moving average basis, the volatile IIP is failing to show any unambiguous trend about growth momentum.”
Economists say growth has bottomed out and industrial production would rebound in Q4. However, figures show the weakness continues. Unless projects are kicked off and the cost of funds doesn’t come down, the virtuous cycle of growth will not start. Explains Saugata Bhattacharya, senior V-P (business & economic research), Axis Bank: “The external environment and domestic situation warranted rate rises till October. Given that business cycles have shortened and the environment is more volatile, central banks need to be more dynamic.”
The central bank has managed to cool the inflation rate from double digits to around six per cent. The consistent weakness in industrial production and downward revisions in Q4 suggest industrial growth is expected to be lower than government estimates. Industrial growth has averaged at 3.5 per cent during April-February FY12. This implies FY12’s GDP growth is likely to fall below 6.9 per cent. Broadly, the belief is the growth-inflation dynamic has reached a stage where a rate cut will eliminate some ills plaguing the economy, like the imported component of inflation, external risks and slowing capital flows. So, the probability of a 25-bp cut in repo rate looks a given.
Morgan Stanley’s Chetan Ahya has been consistently highlighting the “bad growth mix”, wherein private investments have declined and the government has followed an expansionary monetary policy. In a note, Upasana Chachra and Ahya say, what can turn the tide and boost inflows is a correction in the crude oil prices and a positive global capital market environment. They add: “Similarly, the local set of factors could be an aggressive and persistent policy action, which revives private investment sentiment and a simultaneous aggressive reduction in government expenditure. However, we currently see low probability of these positive triggers materialising”.