Is improvement in core sector growth sustainable?

As part of the growth was led by a favourable base, most experts believe there will be some softness but a good monsoon could act as a catalyst

Core sector data, the combined output of eight key industries (cement, coal, electricity, crude oil, natural gas, refinery products, fertiliser and steel), saw a marked improvement in growth in the months of February and March. This metric grew 6.4 per cent in March, a 16-month high. In February, it was a healthy 5.7 per cent.

However, investors should not read too much into this. Mahesh Nandurkar, India Strategist, CLSA, says: “Our analysis shows that a lot of uptick in high frequency indicators is due to the low base effect in the months of February and March 2015; the same is true even for April 2015. Also, February 2016 had one extra day of production. As we go into May or June, many of these high frequency indicators will soften.”

He has calculated adjusted growth for some of these industries for the month of February 2016. He estimates cement production growth will come down to 5.9 per cent after these adjustments from the reported level of 13.5 per cent. Adjusted growth in diesel consumption stands at 5.6 per cent in February, almost a third of the reported growth number of 15.1 per cent. Similarly, electricity generation's adjusted growth comes to 6.3 per cent from 11.3 per cent reported.

Overall, Nandurkar believes February core sector growth was only 2-2.1 per cent, as against the 5.7 per cent reported. If one adjusts for the base effect, the actual number for March would also be lower than the reported figure.

While the adjusted numbers might vary with the assumptions one takes into consideration, many economists agree a low base effect has indeed led to an exaggeration in core sector growth numbers. Does this mean that the growth will moderate? Many economists believe so.

Tirthankar Patnaik, India strategist at Japan-based Mizuho Bank, says: “We expect the core sector growth to start coming off as we get into the monsoon (season) and the base effect normalises. But, electricity will continue to do well, at least till May. Overall, we do not foresee any meaningful improvement in the IIP (Index of Industrial Production) number in FY17.”

On the positive side, even amid this overall slowdown, some segments are witnessing a structural uptick. These include cement and electricity. Shubhada Rao, chief economist at YES Bank, says: “The base effect has definitely pronounced production growth much higher. However, cement and electricity have been trending upwards in terms of momentum. Similar observations are not necessarily true of other components within the core.”

However, the onset of monsoon is likely to curtail the growth of sectors such as cement and mining. Assuming we have a good monsoon, electricity is likely to do better if we add the dynamics of hydro-electricity, adds Rao.

D K Joshi, chief economist at CRISIL, is more optimistic. He believes if the monsoon remains normal, rural consumption demand will improve and create a need for more production of industrial and manufacturing commodities. Patnaik, too, believes that falling interest rates could lead to a minor uptick in consumption demand towards the end of FY17, which in turn could aid manufacturing growth.

For now, though, all eyes will be on the core sector data for May and June. If the improvement continues in these months, it will be fair to conclude a visible economic recovery, adds Nandurkar.