HSBC India Manufacturing PMI bounces back in October

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India
HSBC India Manufacturing PMI bounces back in October
The soft patch may be behind us for now, with the momentum in manufacturing picking up in October.
Manufacturing remains well supported by strong domestic demand, while export orders continue to
expand at a slower pace in line with the softening in global conditions. Indian workers are benefiting from
higher employment, but inflation pressures are lurking, underscoring the need for continued monetary
policy tightening. While these numbers suggest an increased probability that the RBI will tighten on
Tuesday, we maintain our call that it will pause but resume the tightening cycle again in December.
HSBC India manufacturing PMI bounced back to 57.2 in October from 55.1 in September. The rebound
was broad-based, but primarily driven by the acceleration in output growth (62.8 vs. 58.4 in September)
and a faster uptick in new orders (60.6 vs. 58.7 in September). The acceleration in orders would appear to
have been driven by domestic demand, with new export orders growing at a slightly slower pace (53.4 vs.
54 in September), in line with the softer global economic conditions.



The jump in new orders and reported raw material shortages caused a continued rise in production
backlogs (51 vs. 52.7), although the pick up in output growth helped prevent companies from falling too
far behind. The higher level of production also encouraged manufacturers to keep their stocks of finished
goods broadly unchanged following the drawdown the previous month (50.2 vs. 49.6 in September). It
also encouraged them to raise employment (51.0 vs. 49.6 in September), maintain purchasing activity at
elevated levels (56.6 vs. 56.4 in September), and continue to add to their stocks of purchases (55.8 vs.
55.6). The increased purchases by manufacturers led to a slight deterioration in supplier delivery times
(49.6 vs. 50.2 in September), which was also the result of reported supplier material shortages.
Inflation pressures are still lurking. Input prices rose sharply (60.9 vs. 57.8 in September) and they have
now accelerated for four consecutive months, driven this time primarily by the increase in raw material
prices. Output prices also rose at a slightly faster pace (51.6 vs. 50.9 in September), but firms reported
that competition restricted their ability to raise prices. As mentioned in previous commentaries, this could
also reflect the increased competition from cheaper imports.
These numbers are clearly a sign that the economy is "alive and kicking" and that the RBI has to remain
vigilant to prevent inflationary pressures from building and blowing the lid off the kettle. True, there has
been some easing in the growth momentum since the first half of 2010 when the economy was riding the
cyclical roller coaster on its way up from the depth of the global economic crisis. However, the slowdown
in economic momentum since then does not just reflect the softening in global economic conditions and a
sequential base effect, but also that India's economy is now hitting its potential with industrial output
struggling to keep pace with domestic demand.
Domestic demand is expected to remain strong, supported by the favourable monsoons this year,
improved labour market conditions, and ongoing capex expansion by corporates. Moreover, monetary
policy still remains highly accommodative despite the tightening undertaken so far, with current policy
rates well below neutral levels and in negative territory in real terms. This, in turn, should boost private
credit growth, which still is in the early stages of the credit cycle. All of this means that manufacturing
should remain well-supported by strong demand conditions, but also that demand-pull inflation will

become more prevalent. However, demand-led inflation will not be sufficient to counter the supply-driven
base effects, which will "mechanically" bring annual WPI inflation lower towards the end of the year.
So, RBI has its work cut out for it. It has to continue its tightening cycle throughout next year and a
cumulative 150bp is on the cards before policy rates are in line with neutral levels. Capital inflows into
the economy are primarily going to be driven by push factors (amble global liquidity) and growth
differentials to advanced economies, more so than any marginal tinkering with policy rates. The latter
should, therefore, not be a decisive factor in monetary policy deliberations. Moreover, inflows motivated
by bets on the exchange rate could be deterred by letting the exchange rate appreciate further and the
ramifications of more sustained inflows could be addressed through fiscal tightening and/or macroprudential
measures.
What we think: The PMI numbers were strong and highlighted the underlying inflation risks. While
this suggest an increased probability that the RBI may tighten on Tuesday, we
maintain our call that it will decide to pause and wait for the outcome of the US
Fed's much anticipated decision on QEII and also to allow it to gather additional
economic intelligence, including from 3Q GDP data and October WPI numbers.
Nevertheless, look for a resumption of the tightening cycle in December with a
25bp hike in the Repo rate.