The candid message that the IIP numbers offer: Its too early to cheer on the Modi magic

The August factory output data, released on Friday, came as a shocker to most economists and revival optimists, who were expecting better numbers - and a bitter reminder to the Modi administration that it takes real action on the ground to convert sentiments to actual results on the ground.

The Index of Industrial Production (IIP) grew at a mere 0.4 percent in August, same as in the month of July (July numbers were revised downwards to 0.41 percent from 0.5 percent) and much lower than the 2.4 percent predicted by economists at a CNBC-TV18 poll.

The IIP numbers have dampened the sentiments the markets received after a 5.7 percent GDP growth logged in the first quarter of the current fiscal year.

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The biggest drag on the factory output came from the capital goods segment, which is a direct indicator of investment demand in the economy.

Capital goods contracted 11.3 percent (against 3.8 percent in the previous month), while consumer goods sector shrank 6.9 percent (against 7.4 percent contraction).

Manufacturing, which constitutes over 75 percent of the factory output, contracted by 1.4 percent in August compared with a 0.2 percent decline a year ago.

The IIP numbers tell the bitter truth. The much-hyped Modi-wave has not yet translated into the much-needed investments and capital expenditure in the economy, at least so far in this year.

“The expected investments have not happened so far in the economy. Even the consumer demand, after an initial pick up seems to have subsided,” said A Prasanna, chief economist at ICICI Securities Primary Dealership to Firstbiz.

One will have to wait and watch to see how the investment scenario will pan out in the approaching quarters. A recovery in investments will depend on an array of factors that include the course of interest rates in the economy, the implementation of critical reforms (land and labour to begin with) and fast-tracking the clearance process.

Global rating agencies, which have so far responded positively to the Modi regime, too have highlighted the need for growth-oriented reforms in the economy as a prerequisite to positive rating revision.

As for the interest rates, the RBI is on a chartered path to fight inflation and, for now, has its eyes set on a 6 per cent target by January, 2016.

Theoretically, in a slowing growth scenario, the pressure is on the RBI to cut rates mounts. But for now, that possibility looks distant given that retail inflation continues to stay at elevated levels despite showing signs of easing in the recent months.

The scene doesn’t look too good on food and primary goods inflation, which weighs one-third of the wholesale inflation and almost 50 percent of retail inflation. That reduces any chance of rates easing in short-term and reduced interest rate burden on industry.

The next critical number that the financial markets would look at would be the retail inflation numbers slated to be released on Monday.

As _Firstbiz_ noted earlier , despite the optimism among the industries following a stable government at the centre and the Narendra Modi factor, the flow of bank credit to industries hasn’t picked up so far in the economy and has, in fact, contracted to industries.

Bank loan to industries has shrunk by 0.6 percent in the first five months of the current fiscal year compared with a growth of 4.5 percent in the corresponding period last year.

On a year-on-year basis too, bank loan growth remained weak at 7.6 percent to industry as compared with 17.3 percent in the same period last year.

What this means is that, practically, no major bank lending has happened to companies this fiscal so far. Banks-critical stakeholders in any economy–have, thus far been reluctant to act in tune with the Modi wave.

While the course of interest rates in the economy will be a function of price movements, the IIP numbers surely gives a wake-up call to the Modi-government to bring in structural reforms and make actual investments kick-start in the real economy.