Anand Rathi:India Economy – Industrial production – Tail wagging the dog

India Economy – Industrial production – Tail wagging the dog

Strong volatility in capital goods, with less than 10% weight, is making the industrial outlook murky. Yet, deceleration in IIP growth, ex capital goods, since Dec ’09 is largely owing to the base effect rather than fundamental deterioration. Subdued performance of the core sector, however, is a concern. The RBI is likely to hold rates in Nov ’10.

n       IIP growth eludes expectations, yet again. The index of industrial production (IIP) grew 5.6% in Aug ’10, considerably below expectations. Unpredictable sharp volatility in capital goods production is creating disconnect between market expectations and actual IIP data.

n       Broad-based slowdown. Manufacturing sector, which is ~80% of the IIP, grew 5.9% in Aug ’10, down from 16.7% in Jul ’10. Mining and Electricity also saw slow growth in Aug ’10, at 7% and 1% respectively.

n       Large swings in capital goods. Despite less than 10% weight in IIP, sharp volatility in capital goods strongly impacted IIP growth. After 50% mom jump in Jul ’10, capital goods production reduced by 40% in Aug ’10. While growth deceleration in IIP (ex capital goods) since Dec ’09 is visible, overall IIP growth has moved in tandem with capital goods.

n       Consumer goods growth slows down. Consumer durables growth at 26.5% in Aug ’10 remains impressive despite slowdown since Dec ’09. Production of non-durables, on the other hand, declined (by 1.2%) in Aug ’10, for the first time since Jan ’10. Despite emphasis on ‘inclusive growth’, high food prices seem to be containing the non-discretionary spend.

n       Data issues. Large volatility in IIP growth in the past few months is creating ambivalence in decision making for both, the policy authorities and entrepreneurs. Adequacy of IIP data, with FY1994 as the base year, to capture the current dynamics of industrial production is being questioned.

n       Industry outlook. The Aug ’10 data suggest that the spurt in IIP in Jul ’10 was largely a one-off. We maintain our long-held view of IIP growth in FY11 to be below 10%. Yet, the deceleration since Jun ’10 is mainly due to base effect rather than deterioration in fundamentals. Slow growth in core industries, especially electricity, is a concern as it creates supply-side problems for overall economic activities. 

n       Policy rate outlook. Except Jul ’10 data, IIP data since Dec ’09 indicates slowdown in the growth momentum. Also, headline inflation has started softening. These coupled with strong monetary tightening in India since Feb ’10 and expectations of further quantitative easing in major industrialised countries are likely to nudge the RBI towards a pause in the Nov ’10 policy. We do not expect more than 25bps increase in policy rates during remaining FY11.