Editorial: Bottoming out?

Last week brought a sliver of good news on the macroeconomic front. The weekly inflation numbers showed that inflation measured by the Wholesale Price Index came down for the third successive week, an indication that it is on the decline, even though it still remains in dangerous territory above 12 per cent. Softening commodity prices, including oil, are clearly helping and the late recovery of the monsoon will help to keep food prices in check. The Index of Industrial Production (IIP) numbers for July showed that output grew by 7.1 per cent over July 2007. This was significantly above market expectations and suggests that the downward movement of the cycle may not be as strong as was feared. The manufacturing sector grew by 7.5 per cent, compared with 8.8 per cent last July, but significantly better than the 5.6 per cent growth registered during the April-June quarter.

The pattern across the major industrial segments in the manufacturing sector is quite skewed though, raising doubts about the sustainability of the upturn. Transportation equipment, which was a major contributor to the slowdown seen over the past twelve months, showed a sharp recovery, clocking 18.7 per cent in July, which took its growth rate over the first four months of the current fiscal year to over 12 per cent. The price and interest rate scenario did not presage such buoyancy, so it might well be a one-month aberration. Machinery and equipment, whose growth rate dropped significantly in recent months, also staged a sharp recovery, growing by 16 per cent in July. The combined weight of these two segments took the capital goods category to a growth rate of 21.7 per cent, a rather spectacular rebound from the negative movement over the past several months. The other surprise was the consumer durables sector, which, as a category, has been quite sluggish for some time. Last July, output actually declined; the base effect clearly contributed to a significant recovery this July, but the growth rate of 11.2 per cent cannot be due to that factor alone. Just as for transportation equipment, the interest rate scenario does not suggest a buoyant market environment for this category. In both these segments, it is possible that lower production levels over the past few months have drawn down inventories and these are being replenished, which means that the high growth rates in production will not persist. These are hypotheses for both financial and policy analysts to test.

Meanwhile, these numbers increase the room for manoeuvre on the monetary policy for the next quarter. With inflation coming down, there is no pressure on the Reserve Bank of India (RBI) to act before the scheduled announcement at the end of October. By then, the August IIP numbers will provide further evidence on whether the cycle is indeed bottoming out. Recent analysis of corporate capital investment activity by the Business Standard Research Bureau suggested that it had slackened considerably during the first quarter, so the bottom may yet be some distance away. However, if the cycle is indeed turning, the falling inflation rate may persuade the RBI to provide it some encouragement by maintaining the status quo on interest rates in October. Of course, the behaviour of oil prices over the next few weeks will be a key factor in that decision. They could go up as fast as they came down.