March IIP's a disaster, but will Subbarao budge yet?

It's not as if India's policymakers needed yet another wake-up call to understand how grim the situation in the economy is. But the latest Index of Industrial Production (IIP) figures-which show a contraction of 3.5 percent year-on-year in March as opposed to a growth of 4.5 percent in February-is another addition to the long list of exhibits to prove that India's economy is, indeed, sputtering and needs serious policy-making resolve.

Contraction was seen in manufacturing, which recorded a de-growth of 4.4 percent as opposed to a growth of 3.9 percent last month, and mining (-1.3 percent against 2.7 percent). Capital goods recorded a sharp decline of 21.3 percent against a 10.2 percent expansion the previous month. Consumer goods, however, was one of the very few bright spots this month, growing 0.7 percent, vis--vis a negative of 0.3 percent in February.

"The weakness in the headline IIP reading was driven by a sharp fall in capital goods. Capital goods fell back into the negative zone due to a weak investment climate, and also due to a strong adverse base effect," explains Tushar Poddar, chief economist at Goldman Sachs. Growth in basic and intermediate goods was also much weaker than the previous month, he pointed out.

Counting on the RBI governor. Reuters

However, while the Reserve Bank of India had anticipated the need for aggressive action and slashed the repo rate by a deep 50 basis points in its April policy, it's not as if RBI Governor Duvvuri Subbarao will rush to the phone to consult bankers and look at another round of rate cuts after looking at the latest IIP print.

In fact, Subbarao had, even while announcing the April rate cut, given a clear indication that by its own reckoning the growth rate estimate of 7.3 percent for FY13 (2012-13) was near what should be India's trend rate-or non-inflationary growth rate-of 7.5 percent. The RBI had made it amply clear that the headroom for further rate cuts is limited.

"Recent growth and inflation patterns suggest that the trend rate of growth has declined from its pre-crisis peak. Even though growth has fallen significantly in the past three quarters, our projections suggest that the economy will revert close to its post-crisis trend growth in 2012-13, which does not leave much room for monetary policy easing without aggravating inflation risks," the RBI governor had said in April.

Besides, some economists feel that RBI will be guided by other major indicators as well. For instance, the recent Purchasing Managers Index (PMI) reading for April still shows some expansion, and credit growth suggests a pick-up in activity. This, some analysts say, means that despite the IIP number, growth may not be as weak as it suggests.

Leif Lybecker Eskesen, Chief Economist for India & Asean at HSBC, suggests that RBI may not cut rates just yet, depending only on the latest IIP number. "Friday's number may by itself not prove enough to push the RBI to cut rates again. In addition, underlying inflation pressures remain firm and we actually expect core inflation to increase again in April as base effects wash out. Moreover, the weak exchange rate and wide current account deficit in the context of global risk aversion also limits the RBI's room to move," he says.

Goldman's Poddar, however, differs, and expects the weakening trend to increase the chances of more rate cuts by RBI. "We believe that the weak IIP print, along with stable core inflation, increases the probability of further rate cuts by the RBI. We continue to believe that the RBI will cut the repo rate by a further 75 bps in the remainder of 2012. We expect a gradual pickup in activity only by the second half of FY13, once repo rate cuts by the RBI are transmitted into the system which takes about two quarters," he says.

Apart from the repo cuts to ease the liquidity situation, Goldman Sachs expects a further 25 basis points cut in the cash reserve ratio in 2012. But there's also a caveat from Poddar. "The upturn in the second half of FY13 will also depend upon the government moving on delayed policy reforms to boost activity," he says.

Eskesen cautions against over-interpreting the March reading, but says more negative numbers from other indicators may lead RBI to act. "The March IIP number was a negative surprise, but the series' volatile nature suggests caution in over-interpreting just one reading. With other more reliable high-frequency indicators somewhat firmer and inflation still running high, today's number will not by itself persuade the RBI to move again. However, more of the same from other indicators would," he says.

Subbarao may well be waiting for those indicators before getting into a huddle with his colleagues at Mint Road.

Updated Date: Dec 20, 2014 10:06 AM

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