Can the positive sentiment sustain amid weak data?

Poor manufacturing data is being seen as a positive: it might induce rate cuts when the new Monetary Policy Committee convenes in Oct

Sentiment is a peculiar thing. When it’s upbeat, traders find silver linings in bad news. When it’s down, even great news is ignored. At this instant, sentiment is up and the market is interpreting poor data in optimistic ways.

In America, weak employment data has caused joy to traders because it may prevent the US Federal Reserve from raising policy rates in its September meeting. In India, poor manufacturing data is being seen as a positive: it might induce rate cuts when the new Monetary Policy Committee (and new RBI Governor) convene in October.

The Index of Industrial Production (IIP) contracted by 2.4 per cent year-on-year for July 2016 over July 2015. This is the worst year-on-year return since November 2015. Cumulatively, the April-July 2016 period has seen 0.2 per cent expansion compared to the same period of 2015, with the manufacturing component down by 1.4 per cent during this period.

By any standards this is disappointing. It is also at odds with the GVA (gross value added) data for much of the same time period. The manufacturing component of the IIP saw a drop of 3.4 per cent. One item, rubber insulated cables has been a drag on the entire index through the last financial year. The sector has absolutely collapsed, with a large negative impact on manufacturing despite having a low weight.

The poor performance of the insulated cables item hurts the capital goods industry and takes that into very negative territory at -29.6 per cent year-on-year in July. As many as 18 out of 22 industry groups saw some year-on-year expansion in July 2016 but 8 out of those 18 groups saw lower growth rates, compared to year-on-year changes in June 2016.

This poor performance contrasts with gross value added calculations (GVA) for the April-June period. GVA is up by 7.3 per cent year-on-year and manufacturing for the first quarter of 2016-17 financial year was supposedly registering a GVA of over 9 per cent.  

The IIP has a base of 2004-05 and it covers 682 items, comprising 61 from Mining & Quarrying, 620 from Manufacturing and 1 from Electricity Sector with the weights 14.2 per cent, 75.5 per cent and 10.3 per cent, respectively. It tracks about 400 major companies. The GVA calculations are much broader, and based on a more recent fiscal year of 2011-12. GVA takes the performance of lakhs of businesses with many more items into consideration, and it should therefore, be more reliable.

The IIP underperformance would normally have been considered a dampener, however. But, the overall sentiment is positive. So, market players are assuming that IIP will be ignored or sidelined as an inconvenient and inaccurate indicator. At the same time, they are also hoping that the poor IIP data will influence the MPC to cut rates!

A better argument for rate cuts lies in inflation indicators. The Consumer Price Index (CPI) was up 5.05 per cent in August 2016, year-on-year. This was an improvement over July when CPI was above six per cent. Food inflation has slowed down.

The more optimistic of traders are hoping for a rate cut now and this could create its own uptrend.

The MPC is actually unlikely to cut rates in October though it may do so in December if weak growth and low inflation persist. For one thing, RBI would anticipate the Pay Commission bonanza flooding into the economy and it must also manage the rupee while reversing over $20 billion of FCNR(B) swaps. By December, the next US president would also be known and the Fed’s stance would be clearer. Let’s see if the sentiment persists until then.

The author is a technical and equity analyst