The CPI inflation data and the IIP data have shown interesting trends in the last few months. The latest data set on retail inflation announced for February 2019 has shown a sharp revival in CPI inflation. In fact, from a low of 1.97% in Jan-19, inflation has bounced to 2.57% in the month of February. What does this mean for growth and how is growth likely to pan out.
What does the CPI (retail inflation) trend indicate?
As the chart below depicts, the CPI inflation had been depicting a falling trend since it had peaked in June last year. The fall in inflation over the last 8 months has been driven by lower food prices. In fact, the food inflation of most items had turned negative and that trend has sustained since then.
If one were to look at the last few credit policies put out by the RBI, then it has been talking about a best case inflation of 4%. From that perspective, retail inflation is surely under check. However, the only worry on the inflation front is that the low inflation may be due to the farmer distress which means most of the farmers are not getting remunerative prices for their crops. Also the rural inflation has been sharply lower than the urban inflation. This goes to indicate that while urban India has largely maintained its purchasing power, it is rural India that has actually suffered a fall in its purchasing power. That has translated into weak demand and weak inflation. Interestingly, the RBI policy had recently shifted its focus from core inflation to headline inflation. Core inflation continues to remain at above 5.3% although it is just headline inflation that has fallen sharply. What does the Feb-19 inflation indicate? Does it hint at a revival in inflation or is it more about a temporary base effect that will eventually vanish? When you combine the effects of CPI and WPI inflation, it is obvious that the indications are towards higher inflation in the coming months.
But, IIP has been showing clear signs of pressure
The index of industrial production is showing pressure in the last 3 months. Normally, IIP is reported with a lag of 1 month as compared to inflation and hence they may not be strictly comparable. If one were to look at the private sector banks, they are operating on a credit / deposit ratio of nearly 96%. That is nearly 10% higher than the 10-year average. Of course, PSU banks operate on a much lower C/D ratio of around 71% and that is the crux of the problem. It has always been the case of PSU banks lending to industry and private banks focusing on consumer lending. So we have a situation where consumer lending is still happening due to higher income levels but industrial lending is under stress.
What is really worrying is that the pressure on the IIP is coming from the manufacturing sector which accounts for nearly 77% of the total IIP. With most industries still operating at just about 70% capacity utilization, the manufacturing growth is just not happening. That is what is keeping under pressure.
Is this a sign of slowdown and what are the strategy responses?
If one were to look at the overall GDP growth data, the last quarter ended December 2018 had reported a GDP growth of just about 6.6%. The MOSPI has forecast full year GDP growth at just around 7%, which means the fourth quarter could be weaker at 6.4%. To an extent, this slowdown was triggered by the demonetization of currency in late 2016, which led to severe strain on the SME and the MSME sector. That pressure has continued to show. At the same time the trade war and higher crude prices are also putting pressure on the global GDP growth. IMF has already forecast 30-40 bps lower growth in GDP due to the ongoing trade war between the US and China. That is also likely to have an impact on India.
What could be the policy responses? It is broadly assumed that the RBI could cut policy rates by 25 basis points in the April policy. Whether the RBI opts for rate cuts or liquidity infusion remains to be seen. Especially, this assumes relevance in the light of the Dollar Swap bonds announce as well as the weak transmission seen when the rates were cut by 25 bps in February. But a lot would really predicate on the new government that takes oath in May and its policy stance!