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Event update: India Economy; IIP and CPI review: Underlying demand remains feeble; need for stimulus

Consumer Price Index (CPI) for May 2019 strengthened 6bp mom to 3.05% yoy, primarily led by rising vegetable, pulses and sugar prices. However, the fall in core inflation continued at a whopping 30bp mom, indicating feeble demand conditions impairing pricing power amongst manufacturers. Underlying trends in IIP growth painted somewhat similar picture. While headline IIP number for Apr 2019 improved to 3.4% yoy against 0.1% yoy decline in Mar 2019 (which came as a pleasant surprise), the weakness in 6-month moving average for all IIP sub components continued. Consequently, we believe the uptick in IIP growth lacks breadth. Risk to growth is likely to persist due to relapse of global trade frictions, which will impact export-oriented sectors and have a spill over impact domestic activities as well. In light of weakness in the overall demand environment (as exhibited by most high-frequency indicators) and structural challenges faced by the economy (pain in financial sector, weakness in investment cycle, low savings rate, etc.), we expect the government to provide fiscal stimulus, including tax rationalization and higher spending in the upcoming Union Budget. A fiscal stimulus at this stage would be far more effective for demand revival than monetary stimulus, in our view. On the monetary side, while the downdraft in core inflation provides headroom for further cuts, we expect RBI to focus more on liquidity-related support and transmission of existing rate cuts for the time being, rather than further cutting rates in the immediate term

Core CPI continues to fall on weak pricing power: CPI for May 2019 strengthened 6bp mom to 3.05% yoy (Apr 2019 CPI was revised upwards to 2.99% yoy).

• The mild strengthening in CPI was led by vegetables, pulses and sugar. Vegetable price index strengthened 259bp mom (primarily due to seasonal factors) and pulses finally broke their 30-month deflationary streak with 2.1% yoy rise in index (up 294bp mom). On the other hand, another non-core component - fuel and light inflation - eased 8bp mom.
• Core inflation, which is the most stable component of CPI, continued to ease, that too by huge 30bp mom to 4% yoy (CMIE estimates). Weakness in core inflation indicates weak pricing power in manufactured goods in the wake of a weak demand environment, a key concern at this stage. While weak core inflation provides monetary headroom, but we expect RBI to focus more on transmission of cumulative 75bp rate cut already effected. 

IIP headline growth improves, but underlying trend remains weak: Apr 2019 headline IIP growth came in at 3.4% yoy, versus 0.1% yoy decline in Mar 2019. The Apr growth came on a moderate base of 4% CAGR over 2 years. While the revival in headline number is a pleasant surprise, underlying trends do not reflect a sustained uptick yet.

• As IIP tends to be volatile, we have looked at moving averages to ascertain the underlying growth trend. While the 3-month moving average (mma) trend for headline numbers does exhibit a strong trend, overall 3mma growth at 1.1% yoy is not encouraging.
• 6mma trend is even more dismal. All underlying parts of IIP series posted mom decline on a 6mma basis. When we compare 6mma on a yearly basis, we observed a weakening trend there as well.
• In terms of economic activity based classification, IIP headline growth was driven primarily by mining and electricity. Manufacturing growth was rather tepid at 2.8% yoy.
• In terms of usage-based classification, primary goods and consumer non-durables were the only strong components.

·      As global trade environment remains weak, we expect manufacturing to see pressure, which will eventually spill over to supply chain, impacting overall industry growth.