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Event update: India Economy; IIP and CPI review: Modest rise in inflation and weak IIP, a precursor for another rate cut

CPI inflation creeps up further, core remains comfortable: The retail inflation for the Jun’19 crept up a little more to 3.2% from 3.0% MoM. With this the Q1FY20 average stands at 3.07% compared to 2.5% in Q4FY19. The estimated core inflation remained unchanged at 4.0%, which is at the comfortable level and much lower than 6% a year back. Given the expressed concern of the RBI on the economy going off-track at these levels of inflation another rate cut in the August policy announcement looks almost sealed.

The rise in headline inflation is driven by continued but moderate rise in food inflation to 2.4% (45.86% weight in the CPI index) from the deflationary scenario in early 2019. The urban food inflation is higher at 5.1%. inflation for housing (10.07% weight) remained steady at 4.8% while inflation for miscellaneous items came in lower at 4.5% vs 4.6% a month earlier.

Industrial production (IIP) growth for May’19 saw a moderation in growth to 3.1% from 4.3% a month back and 3.8% a year ago. Economic activity wise classification show that this moderation was largely due to manufacturing sector which grew by 2.5%. However, the electricity sector showed strong growth at 7.4%. On the user based classification, strong performance came from consumer non-durables at 7.7% and infra & construction at 5.5%. Growth for Capital and intermediate goods remained weak at 0.8% and 0.6% respectively. The durables segment has remained flat YoY.

 

Outlook: The manufacturing sector PMI for Jun’19 remains steady at 52.1% while there is moderation in the services sector for which the PMI has declined below 50 at 49.6%. The persistent weakness in economic activity is attributable spillover effect of global trade, disturbances in the Indian NBFC sector and lingering impact of constriction in government spending in Q4FY19. Quite clearly the policy response from the RBI to induce liquidity, along with 75bp rate easing and higher spending by the government in Q1FY20 will help arrest worsening of business sentiment.

The key concern is the weak performance of tax collections, which among other things, is significantly impacted by deflation in commodity prices. This is a major challenge for fiscal management amid weak demand conditions. Things can improve if the extant anxiety over global trade conflicts thaw, which can help resuscitate India’s trade activities and revival in global commodity prices will also aid the performance on tax revenue front.

In the base case, to fund its expenditure budget, we believe, the government will have to bear with higher fiscal deficit and scout for alternate resources like reserve transfer from the RBI, using resource of PSU banks, disinvestments etc. Measures taken in the budget like higher taxes for the rich, tax on large cash withdrawal, increased excise duty on petro product prices and increased customs duty on select items should help create short term buoyancy in tax collection. But it will still not be enough to achieve 18% gross tax collection as per the budget.