Retail inflation, IIP growth bring good news for govt, but there may not be immediate rate cuts

The two economic releases on Index of Industrial Production (IIP) growth for December and Consumer Price Index (CPI) for January bring good tidings for the government and the Monetary Policy Committee (MPC). Both have come at better rates than expected though there is still a question mark on the sustainability of these numbers in the coming months. Let us look behind these data points. IIP growth for December at 2.4 percent is better than expected but is still quite anemic considering that growth on cumulative basis is 4.6 percent and to achieve five percent for the year IIP has to witness higher growth in the next three months. This will be a challenge because growth last year for January and February was above seven percent which means that to attain growth of five percent will be difficult. This is so because even the present number is being driven by a few components and growth is not all pervasive. The infra industry component is the driving force with growth of 10.1 percent where steel and cement have dominated. This has been driven by the government which had front-loaded its capex programme especially on roads and railways which is manifested in these numbers. The big question is whether or not it can sustain the same in these months given that the fiscal is already under pressure and that there may be some cuts in capex if the need arises. Besides, this segment cannot sustain high growth on its own. The consumer goods category has been upbeat with durables clocking 7.5 percent and non-durables 4.1 percent for the 9-months period. This is the critical element because finally consumer spending is going to drive growth through better demand. The good news here is that the financing part of auto and durables has picked up from both banks and NBFCs which will keep growth ticking. It may be remembered that October and November were tough times for the NBFC sector with the liquidity crisis. Now with normalcy returning, there is hope of better performance for industries dependent on such credit. The approaching marriage season in March-April combined with rabi harvest in the first phase can add to spending. [caption id=“attachment_4258303” align=“alignleft” width=“300”]  Representational image.. AFP.[/caption] The capital good growth of 5.9 percent is encouraging though it has to be monitored because this number tends to be volatile. RBI data on capacity utilisation shows that there has been improvement in Q2 of this year with the number inching back towards 75 percent. This is also good news for the investment cycle which has been one-sided so far being driven by the government only. CPI inflation continues to be an enigma coming in at lower rates successively which has surprised all forecasters including the RBI. The low base effect should have been driving the inflation number up but it has come in at 2.1 percent which is the lowest since June 2017. Food prices continue to fall which has helped the CPI maintain such low levels. Vegetables, pulses and sugar remain the three segments that have been relentlessly witnessed negative growth in prices. While this has been very good for the CPI, it has caused considerable distress to the farm sector as well as sugar industry. Much of the ills of farmers are due to receiving very low prices in the market for their produce which has led to pressure on debt servicing. Normally food prices should increase by 3-5 percent to provide sustenance to farmers. Also for sugar, the entire industry has problems in terms of paying arrears to farmers which has led to the government having several programmes for providing credit to these mills. Therefore negative food inflation is a mixed blessing. Non-food inflation has been sticky above 5 percent but has been coming down albeit gradually. Lower fuel prices due to crude oil prices coming down have steadied this component. Therefore, there is relief on this side too. Other components like education, entertainment, health, house rent, pan, household goods etc. continue to witness higher inflation rates. What does this mean for policy? The lower inflation rate is even below what the RBI had projected and even today it looks like that the rate will not cross 3 percent this year. This is notwithstanding the unfavorable base effect for the next two months. Also, as the RBI targets headline inflation and not core inflation, it will have to go by this number of 2.1 percent. In this situation further rate cuts seem to be on the cards for the year though may not be invoked in April. The RBI’s policy last week had shown after a long time a focus on growth too, given that inflation was low. Therefore, there is reason to believe that the RBI will continue with cuts as inflation remains low. The response of banks to the rate cut has been slow with limited announcements so far. This being the case there is reason to expect the RBI to also wait and watch for may be another policy before going ahead with rate cuts. Meanwhile, the general elections would also play its role as rate cuts during time of ostensible big spending may be limited. Therefore, while the two bits of news are good for the economy, it may not translate into immediate rate cuts though it would be high on the agenda. There seem to be limited headwinds to inflation as even if oil prices rise or fiscal imbalances lead to higher demand, it is unlikely to push inflation beyond the 3-3.5 percent number which is acceptable for the MPC. Therefore, it is time for optimism to spread. (The writer is a chief economist, CARE Ratings)