IIP data fuels rate cut hopes

As food inflation eases, RBI may start relaxing rates sooner than expected.

After economic growth fell to 6.9 per cent in the second quarter, industrial production has contracted 5.1 per cent in October. All key macroeconomic numbers are showing signs of stress. Though factory output has been slowing over the last few months, the 25.5 per cent year-on-year contraction in the capital goods sector has come as a shocker. The main contributor behind this drastic fall are electrical machinery/apparatus (fell 58.8 per cent y-o-y) and machinery/equipment components (down 12.1 per cent).

For the first time since June 2009, industrial production has slipped into the negative territory. Though it did register growth in the first half, it grew by a modest 3.5 per cent between April-October, compared to 8.7 per cent in the corresponding period previous year.

According to Taimur Baig and Kaushik Das of Deutsche Bank, except for the electricity sector, where growth remained in the positive territory (5.6 per cent y-o-y), manufacturing and mining — the other two key sectors — recorded sharp contractions in October, pushing the three-month moving average of industrial production growth to 0.2 per cent, from 3.1 per cent in September.

Despite its sharpness, many economists believe the contraction to be somewhat exaggerated. Given that Diwali fell in October this year, the number of production days has been lesser. This implies that November could be a better month for industrial production than October. Despite the possibility of improved data in November, weakness is likely to persist, as exports — a big driver of industrial production — are expected to remain weak in the coming months.

In the face of faltering growth and slowing industrial output, many believe the Reserve Bank of India (RBI) will start easing rates sooner than expected. Even as most economists were expecting a rate cut until before the middle of next year, it is now widely believed that RBI may be able to meet its seven per cent forecast by March 2012, given that food inflation has started easing. Says Mole Hau of BNP Paribas: “We are now targeting rate cuts of 50 basis points in the second quarter of 2012 and total cuts of 200 basis points by the end of the first quarter of 2013.”