Weak inflation provides no reason to cheer

Downside risks to GDP growth emerge as factory output weakens, domestic consumption and exports fall

Headline inflation (wholesale price index) for June has stayed below five per cent, but nobody is cheering. Economists are puzzled by the queer case of stubbornly-high consumer price inflation and weak core inflation. While the consumer price index (CPI) has risen to 9.9 per cent, year-on-year (y-o-y), in June from 9.3 per cent in May, non-food manufactured goods inflation has weakened to two per cent from 2.4 per in May.

This indicates that though input costs are rising, manufacturers do not have pricing power as demand is slowing sharply, says Dhananjay Sinha of Emkay Global. Clearly, companies do not have pricing power as demand is falling. Even in the worst of times, consumption has held on but now it has started collapsing, as high prices are hurting sentiment. Industrial output data for May has seen the consumer goods segment contract by four per cent. In May, basic, consumer and capital goods output declined, a phenomenon earlier observed in February 2009. According to CRISIL Research, consumer goods output in May registered one of its highest falls since 2009, reflecting a sharp slowdown in domestic demand, which has been weighed down by slower income growth, high interest rates and high retail inflation.

What does this mean for companies and the economy? Weak industrial output indicates the downside risks to the economy are accelerating. While consensus estimates peg FY14's gross domestic product (GDP) growth at 5.9 per cent, economists believe the five per cent mark is more realistic. Sonal Varma of Nomura expects a prolonged period of slow growth with downside risks to her GDP growth forecast of 5.6 per cent, y-o-y, in FY14. The capital goods segment has been contracting for two years. Weak demand and lack of pricing power means the first quarter numbers may not be promising. Sales growth of Indian companies will remain muted. Also, the fall in the rupee will push up input costs even higher. Not only is domestic demand drying up, exports are not picking up despite the rupee depreciation. Exports fell by 4.6 per cent in June, compared to the

corresponding period of the previous year after contracting 1.1 per cent in May. Sanjay Mathur of RBS believes that none of the major components of growth - consumption, exports and investments - is holding up. He believes these data points are raising the odds that the current financial year's growth may fall short of five per cent.