IIP shocker, but 25bp RBI rate hike ::BofA Merrill Lynch,

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IIP shocker, but 25bp RBI rate
hike
5.6% May 2012 index of industrial production
Actual:          5.6%
Previous:      5.8%
Consensus:  8.5%
BofA ML:      8.6%
Bottom line: 25bp RBI hike on July 26 despite 5.6% May IIP  
„ We do see rising rates slowing growth. Even so, May industrial growth, at
5.6%, did massively surprise our 8.6% forecast, on the downside, on a sudden
15% y-o-y downswing in machinery and equipment. Given the extreme
volatility in the series, data issues probably partly explain today’s poor
numbers. That said, there is no denying that growth is slowing on higher rates.
Yet, we still expect the RBI to hike policy rates by 25bp on July 26 (and 50bp
by October) with June inflation likely to come in at a high 9.6% (consensus,
9.7%) on Thursday. For details about the new 2004-05 IIP series, do read our
last industrial report here.  
Why it matters: Rising rates to pull down growth  
„ Incoming data support our view that rates will pull down growth to 7.5% levels
in 1H12. After all, we expect banks to hike lending rates by 25-50bp by March
2012 over and above the 25bp since last week. As it is, real lending rates, at
8.25% (= 14.25% SBI PLR – 6% inflation), have already crossed the ‘neutral’
level defined by the economy’s 8% potential growth rate. Against this
backdrop, we expect the RBI to cut policy rates by mid-2012.  
Key points: May IIP lower on slower machinery production  
„ We continue to expect industrial growth to slow in 2HFY12 on higher lending
rates (Chart 1). We had built in a bounce in May-June with base effects of
2010’s high growth waning. If the present trend persists, we see a 1% risk to
our 7.4% FY12 industrial growth projection and a 20bp risk to our 7.8% FY12
growth forecast. We will review our numbers next month.
„ The weakness in May industrial growth can be essentially explained by lower
manufacturing growth (Table 1). This, in turn, was reflected in a slower
production of intermediate and capital goods (Table 2).
„ Slower manufacturing activity is largely explained by a 15% downward swing in
machinery and equipment (Chart 3).        
Next up in India: 9.6% June 2011 WPI inflation    
India: Wholesale price inflation (June), Thursday, 14 July 2011.