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Industrial activity in October, at 10.8%, grew higher than expected, led by strong growth in capital goods and consumer durables segments. However, the consumer non-durables segment continues to be weak, which is surprising given that private consumption in the past two quarters has grown at a strong pace. Going ahead, we expect IIP numbers to turn much softer, reflecting strong base effect.
On the monetary policy front, we believe, that despite strong GDP growth and industrial activity numbers, the case for pause remains intact. Inflation is on a softening trajectory while persistent tightness in domestic liquidity conditions has led to a significant hardening in short-term interest rates.
IIP growth surprises on the upside
Industrial production, at 10.8% Y-o-Y, expanded higher than expected in October against 4.4% in September and 10.1% in the same month last year. On the sector front, manufacturing sector growth (at an impressive 11.3%) and electricity growth (at 14-month high of 8.8%) led the momentum in the headline number. On use-based classification, consumer durables and capital goods registered strong expansion. Importantly, the significant jump in the number has been due to the fact that Diwali fell in November in 2010 compared to October last year.
IIP data in recent months has been volatile and, therefore, even though the October number has been strong, the trend in industrial activity, as observed on moving average basis, is clearly moderating. On 3MMA Y-o-Y basis, IIP has been on a softening trend after peaking in Q1CY10. Going ahead, the base effect will be particularly unfavourable and accordingly we expect much softer numbers in coming months.
Consumer non-durables remain weak despite strong private consumption
The consumer non-durables category has been registering weakness for some time. Non-durables had jumped 1.9% in September, but weakened again to 0.1% in October. The M-o-M trend has also been one of weakening in recent months. This is baffling given the fact that private consumption in GDP data has risen at an impressive 7.8% in Q1FY11 and 9.3% in Q2FY11, suggesting that it is reaching the pre-crisis trajectory.
Capital goods rebound sharply; basic goods also inch up
The capital goods segment jumped 22% in October, after posting weakness in the previous two months, possibly reflecting some bunching up of investments. However, on 3MMA Y-o-Y basis, growth in this category has been moderating. Basic goods category also expanded 7.7% Y-o-Y compared to an average of less than 4% in the previous four months. On M-o-M SA 3MMA basis as well, the category showed an uptick after contracting in the previous four months. The intermediate goods category, however, continues to register stable and healthy growth.
Monetary policy implications
While GDP growth and industrial activity numbers have been strong, we continue to believe that the case for near-term pause in monetary tightening by RBI remains intact. Going ahead, IIP numbers are likely to be much softer and inflation is on an easing trajectory (although potential rise in global commodity prices do pose a risk). Meanwhile, the persistent tightness in domestic liquidity conditions has led to significant hardening in short-term interest rates. If liquidity tightness continues, economic growth may be impacted. Against this backdrop, we believe the central bank will prefer to wait and watch the evolving macro economic scenario domestically as well as globally in the coming months, while taking measures to improve liquidity conditions.
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