India: IP print is soft but trade flows are mixed; rate action likely :: JPMorgan,

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India: IP print is soft but trade flows are mixed; rate action likely hinges on Friday’s inflation print

August IP prints at 4.1 % oya, undershooting already-low market expectations, and confirming that industrial growth continues to slow IP softness is more broad-based than the previous month -- basic and consumer goods decline sequentially while capital goods fail to regain last month’s loss September trade flows are mixed as exports continue to surprise on the upside while imports weaken We believe a decision to raise policy rates at RBI’s October review will likely hinge on Friday’s inflation print Given increasing evidence of an economic slowdown and pressure on the RBI to pause, a sequential moderation of core inflation could well induce a pause; conversely, a further acceleration of core would likely induce another 25 bp rate hike Aug IP undershoots already-low expectations… Despite accelerating mildly from last month’s print, August IP growth disappointed (4.1 % oya, -0.6 % m/m, sa) by undershooting already-low market expectations (Consensus and JP Morgan: 4.7 % oya). On a three-month-moving-average basis, IP growth slowed to 5.5 % oya in August from 6.3 % in July. This same trend was visible even excluding the volatile capital goods component from the index. Ex-capital goods, IP growth slowed to 5.2 % oya from 5.9% in July. This is just the latest reminder that industrial growth continues to moderate, consistent with a slowing PMI, indirect taxes and imports. ….and the internals are soft As alluded to above, on the face of it, August’s 4.1 % IP growth was a re-acceleration over the upwardly-revised 3.8 % print in July. However there is a crucial difference. The moderation in July’s print was caused primarily by a sharp plunge in the volatile capital goods sub-component. Ex-capital goods, July IP came out at 7.1 % oya, which was the highest in 4 months. There was no such joy in the August numbers as the softness was much more broad-based. Basic goods and consumer durables, which were a source of strength in July, led the disappointment in August. Basic goods declined 3.5 % m/m, sa on a sequential basis to print at 5.4 % oya, down from an average of about 8 % over the last three months. Consumer durables, too, suffered the same fate, declining 3.5 % m/m, sa. The fall in consumer goods was led by the more interest-rate sensitive durables, which declined 7.4 % m/m, sa after rebounding in July. This is consistent with the moderation in auto sales, for example, and is evidence that sustained monetary tightening has begun to bite. The decline in consumer non-durables was much more tepid (-0.8 % m/m, sa) and is consistent with the fact that rural consumption (which primarily consumes non-durables) is likely to remain strong on sharp rural real wage growth (see, “India: rural wages surge – to support consumption but pressure inflation,” MorganMarkets, October 11, 2011). Given the lumpiness inherent in capital goods production and the extent to which they yo-yo around in the data every month, one expected a sharp pullback in August after the plunge in July (-16.6 % m/m, sa). However, this was not to be. The bounce, if any, was minimal (+ 2.3 % m/m, sa) causing capital goods to print at only 3.9 % oya. Trade flows are mixed: exports hold up but imports weaken In contrast to August IP, provisional trade data for September surprised slightly on the upside. With new export orders with the PMI declining sharply over the last several months and printing below 50 for the last 3 months, one would have expected exports to decline on a sequential basis. Instead, export growth held up smartly growing 3 % m/m, sa and printing at a still-healthy 36.1 % oya. This adds credence to our view that the geographical diversification of India’s exports has held her in good stead in the wake of slowing developed markets. It also underscores the fact that despite the elevated global uncertainty and worries of a slowdown, India’s export sector continues to be relatively insulated from these global worries. In contrast, import growth weakened for a second successive month, declining 7.8 % m/m, sa. However, because provisional trade numbers do not provide the oil and non-oil import breakdown, it is not clear whether the import moderation was another manifestation of a slowing economy or simply a reflection that crude prices corrected slightly in September and one of India’s large refineries temporarily shut down mid-September. In fact, the only other information provided along with the provisional data numbers was that gold and silver imports continue to be strong, suggesting that consumption is continuing to hold up. As a result of these trade dynamics, the monthly trade deficit narrowed sharply to $9.8 billion from $14 billion, a trajectory that was in line with our expectations. Rate hike decision likely to come down to Friday’s inflation print In recent weeks, tremendous pressure has built up on the RBI to pause its monetary tightening cycle from markets and Indian corporates. Even some government officials have publicly stated that a preference for the RBI pausing. This pressure emanates from various factors. For one, a variety of high frequency indicators suggest that activity is slowing appreciably. The manufacturing PMI has fallen for 5 successive months and the September PMI printed at a 30-month low and was barely in expansionary territory. Slowing indirect tax collections in August and September and today’s IP print add further credence to the view that growth is moderating – and is perhaps on a trajectory that some policymakers are uncomfortable with. Second, proponents of a pause argue that significant base effects come into play starting December, and the year-on-year rate is bound to moderate appreciable towards the end of the year. Third, the fact that a variety of other central banks have paused and some have even begun to ease (Brazil, Indonesia, Turkey, Israel) is suggestive of elevated global uncertainty and weakening hopes of a global recovery which would warrant a pause in current tightening. There are, however, several counters to these arguments. For one, inflation continues to remain stubbornly high and thus far has shown no signs of abating, leading to continued elevated macroeconomic uncertainty. Second, despite the fact that commodity prices have eased slightly, a weakening Rupee has more than offset such gains and caused input prices in the September WPI print to increase further. In effect, the sharp depreciation of the currency has resulted in loosening monetary conditions and thereby likely effectively offset some of the impact of the previous rate hikes. Third, the elevated global uncertainty has still not materially impacted India’s export sector, suggesting that India continues to remain partially insulated from global events. Fourth, despite fears of a broad-based slowdown, consumption growth in the coming quarters is still likely to hold up underpinned by buoyant rural wage growth and consumption. Finally, relying on statistical anomalies like base effects is fraught with risk (as the RBI found out at the end of 2010) because inflation could re-accelerate once these base effects wear out. Whether the RBI places more weight on growth concerns or continues to prioritize inflation worries will ultimately determine whether policy rates are hiked on October 25. Comments from senior RBI officials today seem to suggest that, while they are cognizant of the current slowdown, incremental rate hikes will be based on the inflation situation. As such, the decision to hike policy rates will likely come down to the September inflation report to be released on Friday. Given the intense pressure the RBI is under, a sequential moderation of core inflation could well induce a pause in policy rates in October (even though we believe this would be premature). Conversely, if the momentum of core and headline inflation accelerates further, we expect the RBI will continue its monetary tightening process by raising policy rates (most likely one final time) by 25 bps.