IIP readings give mixed signals

With falling inflation and rising real effective interest rates, RBI may cut rates

India’s industrial production data never ceases to surprise the market. The index of industrial production (IIP) grew 6.8 per cent year-on-year in January, after expanding a modest 2.5 per cent in December 2011. Despite moving to a new series last year (with an updated base and higher number of commodities), the month-on-month volatility continues. This print has beaten the market’s modest estimates by a long shot.

Readings for January have yet again thrown up mixed trends. Even as investments are slowing, manufacturing is showing a rebound. This stellar growth in the headline print has been driven by a strong show by manufacturing, up 8.5 per cent Y-o-Y in January. On the other hand, mining remained in the red. Electricity also clocked a modest growth of 3.2 per cent. Industrial production growth through user groups shows it has been driven single-handedly by the consumer non-durable group, which grew 42 per cent Y-o-Y. If one takes out the high growth in consumer non-durables, IIP growth would contract 1.2 per cent. Despite the overall print, contraction in intermediate and capital goods has continued even in January. Given that the intermediate goods segment is a lead indicator of industrial activity while capital goods is an indicator of future investments, question marks over India’s long-term growth potential persist.

Barclays Capital believes other leading indicators like liquidity, interest rates, credit growth and export demand do not suggest a near-term recovery in industrial output. What makes matters complicated is decline in inflation, which has increased the real effective lending rates. The recent moderation in inflation has increased the real effective lending rate substantially as the repo rate has remained unchanged at 8.5 per cent since October 2011, explains Shubhada Rao, chief economist, Yes Bank. This has resulted in clouding the near-term investment outlook. In an environment of falling inflation and higher real effective interest rates, the Reserve Bank of India (RBI) may actually be left with little choice on a rate cut.

While economists like Rao believe RBI may cut the repo rate at its mid-quarter review on March 15 to accommodate the impact of a rise in real effective lending rates, others believe the apex bank will wait till mid-April to see where inflation heads. Given that crude prices have risen, economists believe RBI will watch inflation for a couple of months before cutting the repo rate. Explains Anand Shanbag, head of research, Avendus Securities, “Sustaining the rebound in IIP would require the momentum to expand beyond consumer non-durables into capital goods and intermediate goods. That may depend on a turn in the interest rate cycle and may have to wait until the data on inflation provides comfort after a month or two.”