Firming up

Macro environment may be helping growth revive

The August numbers for the Index of Industrial Production (IIP) and the September numbers for the Consumer Price Index have been released. They both support the view that the economy is in a recovery phase, which should logically lead to higher growth as well as higher inflation numbers. In fact, the IIP reading was very much a positive surprise, with the overall index growing by 6.4 per cent. The manufacturing sector, which accounts for about 75 per cent of the index basket, grew by an even faster 6.9 per cent. Of course, the low base provides a boost, but even then, this is a welcome indication of a benign domestic macroeconomic environment beginning to provide some stimulus to growth. Looking at the use-based classification, the base effect is most pronounced in the case of capital goods and consumer durables, both of which had sharp declines in August 2014. However, in the case of capital goods, the growth during this August more than offsets previous declines, reinforcing the recovery interpretation. Of course, the strength in the capital goods sector flies somewhat in the face of the general perception that an investment recovery is still elusive. According to the monthly reading, production of electrical machinery grew by over 40 per cent year-on-year. The second-quarter results of manufacturing companies should provide better insights into the performance of this sector and, in turn, a clue as to the behaviour of the investment cycle.

On the inflation front, as was generally expected, consumer inflation came in at 4.41 per cent, higher than the 3.74 per cent year-on-year rate in August. This was mostly due to acceleration in food inflation, but even this remained far below the troublesome levels seen for much of the past seven or eight years. Food inflation in August was a modest 3.88 per cent. The waning of the monsoon during August and September has evidently not had much of an adverse impact, partly due to the fact that the abundance of rainfall in the first half of the season helped replenish groundwater and reservoirs, providing a buffer for the second half. There are clearly several nuances to a deficient monsoon. Importantly, apart from the significant moderation in cereal price increases, the rates of increase in the prices of most protein sources and vegetables were modest. The government's responses to the pressure from onions appear to have worked. The exception was in the case of pulses, whose prices increased by almost 30 per cent year-on-year. Here, the monsoon pattern may be playing a role and the rate of increase could persist for a while. Overall, however, the inflation momentum appears to be low and questions could be raised about the Reserve Bank of India's (RBI's) baseline projection of 5.8 per cent in March 2016.

From a policy perspective, since the RBI has just accommodated a relatively benign inflationary scenario, one question at this point is: would the policy action have been the same with these numbers? In all likelihood, the response would have been the same. But, looking ahead, space for further cuts will lie in the inflation trajectory consistently undershooting the RBI's projections.