By Invitation. Reading trends in key economic indicators

Data on inflation and industrial production of the past few months underscores a modest economic recovery under way in India without inflationary consequences.

Consumer price index (CPI)-based inflation slipped to 4.4 per cent in February 2018 from 5.1 per cent in January, marking the second consecutive month of decline. In the last quarter of fiscal 2018, CPI inflation is set to undershoot the Reserve Bank of India’s (RBI) forecast of 5.1 per cent.

The Index of Industrial Production (IIP), too, continued its strong growth momentum and underlined its broad-based credentials with 7.5 per cent growth in January.

The recovery is complemented by rising credit growth and some improvement in exports. The waning impact of demonetisation and the ironing out of the Goods and Services Tax (GST) creases will also support domestic industrial activity.

But here’s a sobering thought: IIP growth till date (April 2017-January 2018), at 4.8 per cent well trails the performance in the same period in 2016-17. So how durable is the industrial recovery and the decline in inflation? And specifically, does undershooting inflation imply incipient softening in the RBI’s stance?

Broad-based IIP recovery

IIP data today is well-scrubbed after having triggered several false starts over the past few years led by idiosyncratic factors. For example, a few years back, a surge in ‘hair oil’ production led to a pick-up in the index. And in fiscal 2010, stupendous growth in the production of alarm clocks lifted it again. The new IIP series has got rid of items such as typewriters, alarm clocks and hair oil and therefore is a more germane measure.

The current recovery in IIP is broad-based, with transport equipment, infrastructure and construction goods growing at a fast clip.

In fiscal 2019, several factors will support industrial recovery, such as the enhanced ability of the manufacturing sector to take advantage of global recovery because domestic constraints are being sorted, the implementation of House Rent Allowance recommendations at the State level, expectation of another spell of normal monsoon, and sharp policy focus on enhancing farmer incomes and rural construction. While we do not presage industrial growth rebounding to double digits, an improved scenario is surely on the anvil.

Consumer inflation was the other data point that brought some cheer in March. Food inflation fell nearly 150 basis points (bps) on-month, while core inflation was flat.

Inflation in housing — the category that had rapidly been pushing up core inflation for the last 7-8 months — was stable at a high 8.3 per cent.

CPI inflation averaged at 3.5 per cent fiscal 2018 to date, a sharp slide from 4.6 per cent for the same period in fiscal 2017, and driven by lower food and core inflation. Looks like 2017-18 will end with average inflation of about 3.5 per cent and last quarter inflation at about 4.6 per cent — or well below the 5.1 per cent projected by the RBI during its review of monetary policy in February.

We expect CPI inflation to move up to 4.6 per cent this fiscal. The pick-up will be due to rising consumption demand, impact of house rent allowance revisions on housing inflation, and higher global crude oil prices.

To be sure, higher MSP and increased ambit of procurement could raise food inflation. Also, with demand picking up, manufacturers could pass on input cost increases.

On the other hand, downward pressure on inflation could materialise if reduced rates under GST are passed on to the end consumer. Typically, tax increases get passed on faster and in full, compared with tax declines.

And despite the recent fall in inflation, the RBI is likely to stand pat on rates through the first half of this fiscal, possibly followed by a hike of 25 bps in the second half with inflation risks not fully abated.

The writer is Chief Economist, CRISIL

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