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Event update: India Economy; CPI, IIP review - Improving hopes of a better H2FY20

While CPI for Aug-19 has broadly in line with expectations, IIP for Jul-19 has surprised on the upside. We discuss these two data points below:

• CPI for August-19 up 6bp mom at 3.2%yoy: Core inflation remained broadly flat too at 4.4%yoy, same as Jul-19. While most components were more or less flattish; vegetable prices and fuel prices charted opposite trajectories, thus counterbalancing any impact on headline number. Vegetable prices index strengthened ~400bp mom, primarily led by urban series. Fuel and light series eased by 141bp mom.
• Jul-19 IIP growth surprises with 4.3%yoy growth, we observe a strengthening trend on moving average basis: Jul-19 IIP growth at 4.3%yoy comes on a reasonable base (6.5%yoy growth in Jul-18). While 2 year CAGR for July IIP growth is at a reasonable 5.4%, 3 year CAGR (pre-demonetization base) is at a meeker 3.9%. Both 6 month and 3 month moving average series, exhibited a strengthening trend for headline number. 6 month moving average series is exhibiting a slight trend reversal towards strengthening momentum after 14 months of downward trend. On economic activity side – manufacturing and mining exhibited strength, while on usage side strength was led by consumer non-durables and intermediate goods. Consumer durables and Capital goods continue to be weak though.

IDFC Outlook

We have attributed current economic slowdown to: a) lingering effect of demonetisation & GST dislocations, b) global trade disturbances, resulting in deflation in commodity prices, c) restrictions in government spending due to tax revenue shortfall and d) the NBFC crisis. These factors have also kept the headline CPI inflation at sub-4%, despite the gradual rise since early 2019.

We believe some of these factors are changing. First, over the past one month, government has taken measures to improve cash flows, especially for the MSME sector. GoI has started spending again. RBI and GoI have actively worked to hasten the transmission of the front loaded cumulative 110bp rate cut to 5.4%. In addition, there is an improvement in terms of trade for the agri sector, which reflects in rising relative primary food prices (including in WPI) vs rest of the components. This suggests that as government begins to spend on rural (another area of policy focus), there should be improvement in rural demand against deceleration seen in the past few quarters. Also, from the global standpoint, improving prospects of trade talks between US and China are reflected in improvement in sentiments, which is a conditional positive for global growth and commodity prices. If it continues in that direction, a major portion of pessimism can start to wane. We caveat this outlook in the realms of recent back and forth position taken by US on trade policies.

Overall, we maintain our view that the H2FY20 holds a better prospect compared to the very pessimistic situation that has panned out in H1 and since Dec’18. We expect the simulative measures taken by the RBI and governments to pan out effectively over the next 6 months. We maintain earlier thesis on G-sec yields hardening, details at . India Gsec yield curve has steepened after the last 35bp rate cut by RBI to 5.40% with 10 year rising to 6.67%, up from 6.30% in Jul’19. The 30-year benchmark hardened even more by ~45bp to 7.1%. We see fair possibility of 10 year inching closer to 7% in a few months.

Given that RBI has already frontloaded the rate easing (~110bp) and that the real rate at 1% (repo rate at 5.4% and core CPI inflation at 4.4%) is fairly accommodative and only marginally higher than for the US at 0.65%, we believe going forward RBI’s action will be data dependent. Hence, additional 25bp rate easing will be more calibrated, ie it will be utilized if the stimulative actions do not result in demand revival. In the near term RBI will assess the impact of benchmarking of lending rates to repo rate, which is yet to work its way through the banking sector and the economy at large. Consequently, we expect both fiscal and monetary positioning to remain accommodative. We expect the demand triggers to improve more from fiscal measures, lagged impact of recent INR depreciation & rate easing and improvement in global trade.