IIP improves while inflation edges higher

Indian Economic Update

Indian Economic Update
IIP improves while core CPI inflation edges higher

IIP: Modest pick up shows that growth momentum is improving

Headline Index of Industrial Production (IIP) growth showed some improvement, growing by 4.9% YoY in April 2018 against growth of 4.4% in the previous month, although it printed below our expectations of 5.7%. The sub-components of the IIP reveal the following:  

  • Perhaps the most encouraging aspect is the improvement in mining sector production. It grew by 5.1% in April 2018, compared to a growth of 3.1% in the previous month against 2.5% growth witnessed over the previous fiscal year. Hence, it is likely to emerge as upside driver, adding to the momentum of overall industrial Gross Value Added (GVA) growth. 
  • Manufacturing production did tick higher, from 4.7% in March 2018 to 5.2% in April 2018, driven by improving domestic demand. Within manufacturing, the sectors that have shown strong growth are computer electronics, food products and motor vehicles, highlighting that production was broad-based. The main laggard was textiles
    (-13.4%) that implies that labour-intensive sectors are still struggling. A further acceleration is likely over the course of the fiscal year as consumption and investment spending pick up.  
    The main message is that underlying growth is improving and that fits in with our expectations of an improvement in GVA growth in Q1 FY2019 driven by an improvement in both manufacturing and the mining sector. Rural consumption and the public capex cycle are likely to emerge as important demand-side supports.


Core inflation moves beyond the 6% YoY mark
Consumer Price Index (CPI) inflation moved to a 4.87% YoY in May from a 4.6% YoY in April, slightly lower than our expectations. Core inflation moved up to 6.18% versus 5.92% last month at the back of high month-on-month momentum seen in transport and in sin goods of 82 basis points (bps) and 64 bps, respectively. Housing moderated to a 21 bps month-on-month from a 63 bps last month.


Key takeaways are as follows:

  • Food inflation was at 3.1% YoY versus 2.8% YoY last month. This was primarily driven by prices of vegetable, meat and fish MoM momentum of 2.34% and 1.52%, respectively, even while fruit momentum moderated to 0.91 bps MoM from 5% MoM last month. Sugar inflation plummeted further to -8.12% YoY on account of the sugar supply glut, mirroring global sugar inflation at -23.1% YoY.
  • Core inflation moved up further by 46 bps to touch 6.18%, at the back of high MoM momentum seen in transport and in sin goods of 82 bps and 64 bps, respectively, even while housing inflation cooled down to MoM of 21 bps versus 63 bps last month.  
  • Within the miscellaneous category, momentum of all services except transport cooled down, leading to a MoM increase of 53 bps versus 77 bps last month. While transport and communication services were at 5.3% YoY, the recent cuts in petrol/ diesel prices might assuage the momentum (cumulative INR 1.92 cut in the first 12 days of June — in Delhi), even while input costs continued to put pressure on the other components.


On the basis of the latest CPI print, and assuming that 1) core inflation doesn’t surprise further on the upside 2) food inflation remains moderate, we expect inflation to average 4.5% YoY in FY2019. This excludes the impact of Minimum Support Price (MSP) raises which could increase the annual CPI reading by at least 50 bps in FY2019. 
Given that core inflation, excluding volatile components of transport and housing, was at 5.7% YoY versus 5.4% YoY last month (indicating continued input cost pressures), we maintain our call for another rate hike for the fiscal. Incremental data on crude prices, input costs, MSP increases and Government finances will play on the decision of an August or an October hike, in our view.

Trade concerns and volatility in financial flows to materially affect external outlook.
Current Account Deficit (CAD) remained elevated amid high imports.

  • CAD widened to USD 13.0 billion (1.9% of the Gross Domestic Product (GDP)) in Q4 FY2018 from USD 2.6 billion (0.4% of GDP) in Q4 FY2017, but moderated slightly from USD 13.7 billion (2.1% of GDP) in Q3 FY2018. The print was in line with our expectation (USD 12 billion), and the outperformance of imports relative to exports worsened the deficit on a yearly basis.
  • Net services receipts increased by 9.0% YoY mainly on the back of a rise in net earnings from software services and other business receipts. Transfer receipts also showed a USD 2 billion rise in annual terms as oil prices were considerably higher, aiding private transfers.
  • Income related outflows rose in Q4 FY2018 in annual terms led by higher outflow of investment income.

Capital flows mix turned favourable in Q4 FY2018

  • Overall capital account surplus (including errors and omission) rose sharply to USD 26.3 billion from USD 10.8 billion seen in Q4 FY2017 and from USD 23.2 billion in sequential terms.
  • Foreign Direct Investment (FDI) related flows rose to USD 6.4 billion in Q4 due to lower FDI outflow from India. However, portfolio flows shrank steeply in Q4 FY2018, as that quarter saw sharp outflows from debt and equity markets during February in the wake of a global rout which followed fears of swifter tightening in the US. Given the relatively volatile nature of portfolio flows as compared to the stable nature of FDI, this is a relatively favourable mix to finance the CAD, as compared to the trend seen in Q3.
  • The receipt on account of non-resident deposits was significantly higher at USD 4.6 billion in Q4 FY 2018 as against USD 2.7 billion in Q4 FY2017. Overall, balance of payment was at USD 13.3 billion in Q4, much higher in annual and sequential terms.

For FY2018, CAD stands at USD 49 billion (1.9% of GDP), as compared to USD 14 billion (0.6% of GDP) in FY2017. A significantly higher merchandise trade deficit has fuelled almost all of the worsening of the CAD. For the year as a whole, basic balance of payment (CAD+FDI) turned negative, which adds to external vulnerability. However, services and transfer receipts saw an annual improvement in FY2018. Capital account surplus rose sharply to USD 92 billion from USD 37 billion over the past fiscal, aided by significantly higher portfolio inflows (following a sentiment revival after reform measures such as Goods and Services Tax (GST), sovereign rating upgrade and better growth prospects).


External metrics to deteriorate this fiscal
We expect the CAD to print at 2.5% of GDP this fiscal, led by material deterioration in the trade deficit. In the light of current Foreign Institutional Investor (FII) outflows (USD 7.5 billion in Financial Year-To-Date (FYTD)), support to the capital account from FII inflows will be limited this year. Accordingly, the Balance of Payment (BoP) could stand at a deficit of USD 9 billion in FY2019. We expect USD/ INR to trade at 66.50-68.50 over this fiscal with the possibility of intermittent spikes beyond the upper band if there are adverse global shocks or tail-risk events. Subdued geopolitical risks and a softer Dollar over the medium term may cap a sharper depreciation.


Other important developments during the week:

  • The government of India has initiated a committee of bankers to look at the possibility of setting up a ‘bad bank’ and other new mechanisms to help resolve stressed assets faster. After a session with Public Sector Bank (PSB) chiefs, interim Finance Minister Mr Piyush Goyal claimed, “A committee has been set up under the chairmanship of Mr Sunil Mehta of Punjab National Bank (PNB) to deliberate whether it is worth considering setting up an Asset Reconstruction Company (ARC) or an Asset Management Company (AMC) to deal with assets having exposure to several banks.”
  • Reserve Bank of India (RBI) Governor Mr Urjit Patel told a Parliamentary panel that the RBI needs more powers to oversee PSBs, amid mounting bad loans in state-run lenders. The Governor told the panel that steps were being taken to strengthen the banking system.
  • Wholesale inflation rose to a 14-month high to 4.43% YoY in May from 3.18% YoY in April on increasing prices of petrol, diesel and vegetables.

Global Update:

US Fed: More hawkish than expected

  • The increase in the Federal fund’s target range to 1.75%-2.00% was widely expected. However, the policy statement along with projections came in more on the hawkish side than what we had anticipated.
  • We view the policy statement, revisions to economic projections and the post policy conference on aggregate as coming in more on the hawkish side than we anticipated.
  • We revise our expectations of two more cumulative rate hikes in 2018.
  • The USD could benefit from a hawkish Fed, but we will continue to watch the ‘US protectionist push’ carefully.
  • The US yield curve is likely to move higher but the shape is likely to remain unchanged.

ECB Review: An unexpected dovish turn

  • The European Central Bank (ECB) left key rates unchanged and resorted to an unexpected dovish turn in its monetary policy framework. The Quantitative Easing (QE) programme was extended from September 2018 to December 2018 with a lower quantum of net purchases over the October-December period. 
  • There was an additional assurance provided in terms of its forward guidance that ”policy rates will remain low through at least the summer of 2019”.
  • We interpret this sudden turn to imply that the ECB is becoming more concerned about growth and worried about the sluggishness in core inflationary pressures.
  • The dovish turn will likely mean a lower trajectory for the EUR/USD pair.

Other important developments during the week

  • US President Mr Donald Trump refused to endorse a G-7 declaration calling for a reduction of tariffs and other barriers to trade, as he continued to express disappointment over trade with traditionally close allies. 
  • In the historic summit aimed at normalising bilateral ties and complete denuclearisation of the Korean peninsula with North Korean leader Mr Kim Jong-un, President Trump said that talks were productive, and the US will stop conducting military drills in the Korean peninsula.
  • According to official sources, Mr Trump has decided to impose “pretty significant” tariffs on Chinese goods, as Beijing warned that it was ready to respond if Washington chose to intensify trade tensions. Mr Trump is due to unveil revisions to his initial tariff list targeting USD 50 billion of Chinese goods. The list will contain 800 product categories, down from 1,300 previously, according to another administration official and an industry source familiar with the list.


Domestic benchmark equities started the week in green on optimistic buying in blue-chip stocks, ahead of the release of industrial production data. Sentiments were also lifted by gains in Asian stocks. Sentiments improved after Mr Trump and Mr Jong Un pledged to work towards complete denuclearisation of the Korean peninsula.

Equities continued their rally, buying picked up after official data showed industrial output expanded by 4.9% YoY in April this year, spurred by higher growth in manufacturing and mining sectors. However, concern prevailed over retail inflation inching up to 4.87% in May, on increase in food prices.

Indices turned negative towards the end of the week amid weak global cues. Participants’ risk appetite took a hit from negative global sentiment after the US Federal Reserve raised interest rates for the second time this year and hinted at two more hikes in 2018. India’s May Wholesale Price Index (WPI) which rose to a 14-month high at 4.43%, also dented the trading sentiment.


During the week Sensex gained 0.50% to close at 35622.14 and Nifty advanced 0.46% to close at 10817.70.


Government bonds started the week slightly lower. Market players remained cautious ahead of the CPI-based inflation data and US Federal Open Market Committee (FOMC) meet outcome. Rise in US yields, coupled with rising oil prices, also weighed on prices.

Gilt ended higher during mid-week despite sharp rise in core inflation as fall in crude prices in Asian trade prompted short covering. Lack of weekly gilt auction this week also provided support to bonds. Higher-than-expected WPI heightened fear of RBI rate hikes. Yield on 10-year bond briefly topped the psychologically significant 7.95% mark. Sentiments weakened after US Fed indicated four rate hikes in 2018 versus three earlier.


The 10Y benchmark yield ended at 7.89% as against previous week’s close of 7.95%.


Oil prices edged lower by 0.9% on Monday, following early indications that Russia has increased production in the month of June. There were similar reports of Saudi Arabia also increasing its production in the subsequent months, which go contrary to the expectations/ demands of some other Organisation of Petroleum Exporting Countries (OPEC) members. However, there continues to remain a risk in terms of further decline in output from Venezuela and Iran. According to sources, Indian refiner Nayara Energy, one of the country’s biggest buyers of Iranian oil, began cutting imports this month after the US pulled out of the nuclear deal. This is the second such indication after Reliance also showed an inclination to cut imports from Iran.

Oil prices fell further following the release of the OPEC monthly oil report. The international benchmark edged lower as the Saudi oil minister mentioned that there would be an agreement to increase supply in the meeting next week which would be reasonable and modest and that Iran and Venezuela will be on board as well.


Gold fell by 0.1% at the start of the week as risk on sentiment ahead of the US-North Korea summit saw investors dump the safe haven metal. Gold was trading above the USD 1,300 per oz handle in early Asian trade on Monday after the fallout of the G-7 leaders in the Canada summit over the weekend, but that was quickly reversed as investors turned their focus to other major events lined up for the week.

Gold edged lower after a better than expected US-North Korea summit in Singapore. As per the official statement, Mr Trump committed to provide security guarantees to the Democratic People’s Republic of Korea (DPRK), and Mr Jong-un reaffirmed his firm and unwavering commitment to complete denuclearisation of the Korean Peninsula.

Gold edged higher towards the end of the week, hitting a two-week high, as the Dollar fell and trade tensions between US and China supported the metal. The hawkish FOMC statement on increasing rates by four times this year was largely balanced by the press conference later which contained any sharp reaction on markets.


The Rupee strengthened against the US Dollar during the beginning of the week. However, some gains were erased on oil importers’ Dollar demand. Firm Dollar index weighed on the Rupee. Dollar sales by some foreign banks and exporters supported the sentiment.

The Rupee weakened as the Dollar index gained after positive US CPI data. Exporters’ Dollar sales, coupled with positive local equities, supported sentiment. However, importers’ Dollar demand weighed on the Rupee.

Increased Dollar demand by a big Public Sector Undertaking (PSU) bank, likely for importers and weak local equities, weighed on the sentiment. However, Dollar sales by foreign banks and exporters supported the currency.


Source: ICICI Bank Research and Bloomberg.