Slowing IIP no reason to panic

RBI’s policy tightening has worked; rate cycle could be close to peaking out.

With every passing month, the slowdown in industrial growth is becoming more pronounced. India’s factory output is faltering — at a much faster pace than expected. Growth is moderating in response to monetary tightening, uncertainty over high inflation, and tight capacity. Factory output growth in May has slowed to 5.6 per cent year-on-year (y-o-y), which is significantly below consensus estimate of 8.5 per cent. Marketmen are hoping that this could probably mean an end to monetary tightening, as growth has significantly come off.

Looking at the sectoral performance, mining IIP has grown 1.4 per cent y-o-y, while electricity has put up a strong show clocking 10.3 per cent growth. The index-heavyweight manufacturing has grown 5.6 per cent in May, thus contributing to the overall slowdown. The slowdown is broadbased, unlike the past.

To iron out the monthly volatility for a clearer picture, Nomura has used the three-month moving average (3 mma) growth to smoothen any outliers. On the basis of this model, growth averaged approximately 7.4 per cent during January-April, and moderated to 6.8 per cent in May. Interestingly, there was a shift in the growth composition, as capital goods output growth (3mma) increased from a low of 6.1 per cent y-o-y in March to 10.3 per cent in May. This suggests there was a marginal pickup in investment activity in the first quarter of FY12, after a dismal fourth quarter in the last fiscal. Even as investments improve, consumer demand appears to be waning.

Leif Lybecker Eskesen, chief economist for India & Asean at HSBC, believes it’s too early to panic. Even as y-o-y growth has slowed down, sequentially the picture is not so bad.

Thus, with growth moderating and not collapsing, the RBI’s primary focus will be inflation, and Thursday's WPI reading could confirm this. Consequently, the RBI will continue to tighten rates, taking them to 75 basis points this year.

If the interest rate cycle is actually close to peaking, then this could be a positive trigger for the markets. According to the Royal Bank of Scotland Asia Securities, “Core manufacturing inflation has generally lagged IIP growth; we believe y-o-y it has peaked at 8.5 per cent in March, and should moderate to around six to seven per cent by year-end because of weakening demand.”