This week has been quite eventful beginning with the resignation of Urjit Patel, governor of the Reserve Bank of India (RBI). This was followed by the outcome of the Assembly elections results which may be interpreted as being a surprise. The market had digested this news with equanimity and before the day ended a new Governor was appointed for the central bank. On Wednesday, Shaktikanta Das took charge as Governor and also spoke to the media, thus quashing any speculation.
Das held a short open session with the media without the company of the deputy governors and came across as being friendly and communicative. Without giving anything away on policy he stated in his preamble that he would work keeping in mind the autonomy and credibility of the central bank. He could not have done better. While taking on questions, he referred to growth being important and that inflation targeting would be in the purview of the Monetary Policy Committee (MPC). The Index for Industrial Production (IIP) and Consumer Price Index (CPI) announcements followed probably an hour after his interaction and prima facie bring good tidings.
IIP growth comes in at 8.1 percent which was better than expected even though it had the advantage of a low base of 1.8 percent last year. What was significant is that all the three cylinders have fired with mining, manufacturing and electricity doing very well. Further, within manufacturing, growth was evenly distributed across automobiles, machinery, chemicals, drugs, textile products and electronics. There is little reason to be unhappy as even the use-based classification shows that capital goods and consumer goods have performed very well. While it looks euphoric on the face of it, there is a need to pause and think of what lies ahead.
The base effect will diminish in the next three months and with high growth rates of above 7-8 percent in November and December, growth will get depressed. This is not good news. Also, the high growth in October disguises the impact of the so-called liquidity crunch during the festival season in the non-banking financial companies (NBFC) sector. In fact, October and November have been the critical months when the liquidity issue surfaced leading to controversy with the central bank. NBFCs typically lend to SMEs, auto sector and real estate. The first two get captured in the IIP. But it looks like that there was no impact in October.
Two things are possible now. If the impact does not surface in November, then the initial hypothesis that the liquidity crunch came in the way of growth will be negated. Alternatively, if the impact is felt in November, it will result in a low industrial growth number which can also turn negative given the intensity of the liquidity crunch. But statistically speaking we can still think of attaining growth in the range of 5-6 percent for the year with the first seven months being in this bucket.
Inflation at the retail-end was expected to come down sharply due to the base effect again. At 2.3 percent it is one of the lowest inflation numbers and was not out of sync with the estimates put out by economists. Here, too, there are curious observations. The first is that this has come down mainly due to negative growth in food inflation. While this sounds good for the consumer, it is also a reflection of the failure of the minimum support price (MSP) scheme that was announced as there has been distress sale for most crops where there has been good production. This has had political ramifications at the elections this time and hence has to be introspected.
Second, non-food inflation is still high at slightly less than 6 percent and has been fairly rigid. Fuel, housing, education, clothing, recreation, health, etc. have witnessed close to 6 percent inflation. There has been some moderation in clothing and footwear.
The MPC has certainly been keeping a close watch on this number when taking a stance. While the inflation forecasts have been coming down which gives an indication that they expect price increases to moderate, there is skepticism on core CPI inflation. And this is the inflation which gets affected by demand conditions which can increase if interest rates come down. One can surmise that it is this factor which has kept RBI guarded on monetary policy decisions.
CPI inflation will increase gradually now as the index had peaked last year and started moving downwards. Therefore, we can expect inflation to go up but it is unlikely to cross 4 percent and will move gradually towards this number under normal conditions. Oil price will still matter as well as any recovery in farm prices which may be taken up by the government given the flow of events leading to the elections. Therefore, unless everything goes right, the MPC may not go for a rate cut and prefer a change in stance to neutral.
The next few months will be interesting. The RBI will take a stance on several pending issues which will be watched. Industrial growth will be subdued and hence the private sector and government must continue to work on bettering this number. Inflation will increase though not significantly and it is unlikely to lead to rate cuts this financial year.
(The writer is chief economist, CARE Ratings)
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Updated Date: Dec 13, 2018 09:01 AM