Indian Economic Update
Economic Survey: Cautious on growth; highlights disinflationary impulses
- Survey highlighted sources of optimism from various fronts such as beneficial effects of demonetisation, implementation of GST, actions taken to resolve the economy’s twin balance sheet problem and other fiscal related measures such as reduction of subsidies and privatisation of entities such as Air India.
- Survey sounds cautious on the growth front and expects inflation by March 2018 to stay below RBI’s medium term target of 4%.
Survey expects downside risks to growth on account of various factors
- Previously, the Economic Survey had pegged growth rate for FY 2018 at 6.75-7.5% on the back of strong exports, post demonetisation boost in consumption demand and easier financial conditions.
- However, the revised Survey now highlighted some factors which would lead to a possible slowdown in economic activity.
- The major risk factors highlighted were appreciation in the real exchange rate, balance sheet stress in sectors such as power and telecommunications, stress in the agricultural sector, farm loan waivers and temporary disruptions in supply chain on account of GST implementation.
Survey highlights possible structural disinflation in the country
- On the inflation front, the Survey said that CPI for the past few quarters had undershot general expectations on a sustained basis and it was possible that the trend could continue.
- The Government noted that there have been “permanent developments” in the international crude market and in domestic agricultural prices which would both lend disinflationary impulses. The impact of GST and Pay Commission are likely to be more statistical in nature and they expect the Monetary Policy Committee to see through the impact.
- Given the caution on the growth front and the significantly weak outturn of the growth numbers in Q4 FY 2017, output gap is likely to stay negative for longer. This will also imply that aggregate demand related price pull pressures will not materialise substantially.
- The Survey concludes that the combination of these factors will help to keep March 2018 CPI under RBI’s medium term target of 4%.
Economic survey flagged critical issues
- The Survey has highlighted other issues such as the need for agricultural yields to catch up with global yields. Other factors to be addressed are the small size of the farms and availability of credit.
- It has also expressed concern about the fact that industrial production and services growth in the economy have slowed down sharply and has emphasised that all policy initiatives taken so far should be effectively utilised to boost growth in these two areas.
- The Survey highlighted the challenges faced by the health and education sectors as well and has advocated tackling these challenges on a priority.
- India also has to grapple with the problem of providing jobs for its considerable number of informal, unorganised workers.
- The Government will also have to address skill gaps and reassess the existing framework of labour laws in the economy.
Implications for monetary and fiscal policy
The Survey concluded that the current policy rate is higher than the neutral nominal rates by 25-75 bps and also said that scope for further monetary easing is considerable.
On fiscal policy some concerns have been voiced mainly from possible lower tax collections as a consequence of lower growth and reduced mobilisation of non-tax receipts such as spectrum fees etc. However, compliance benefits from GST is a wild card and will have to be watched for its impact on tax collections.
Inflation picks up amid sharp rise in vegetable prices
- India's annual consumer price inflation picked up to 2.36% in July from 1.46% in the previous month. Pickup in vegetable prices as well as core inflation were the key drivers of inflation.
- Within the food category, vegetables and protein prices contracted by 3.6% YoY and 3.0% YoY respectively while cereal prices softened to 4.0% YoY (vs. 4.4% previously). While the food price inflation has picked up from -1.2% YoY to 0.4% YoY, prices of food ex vegetables have continued to soften. However, sequential momentum for vegetables was sharply higher at ~20% MoM, which led to an increase in the main food index.
- Though core inflation has picked up during the month of July, the performance would have been muted if not for the staggered introduction of the HRA hikes. The performance of other subcomponents was mixed. While pan, tobacco etc. and miscellaneous ex transport inflation picked up, transport inflation saw a softening trend.
- Going forward, the spike in vegetable prices is expected to last in the near term, but better harvests should help in moderating prices going ahead. Toward the end of the year, adverse base effect is expected to weigh on headline CPI. Meanwhile the market will look for cues from the minutes of the August policy meeting scheduled for Wednesday. Overall we believe that the possibility of any further rate cut by the RBI has reduced considerably.
WPI inflation increases after 5 months mainly led by food
- WPI printed 1.88% YoY in July 2017 which was the first increase after 5 months of disinflation.
- The increase in primary inflation was driven mainly by food prices and specifically by vegetables, which grew by ~49% MoM.
- Core WPI was more muted and ticked up slightly mainly on industries such as wood, paper, furniture etc.
Given the favourable monsoons and pattern of crop acreage, we believe that momentum for food inflation should ease over the latter half of the fiscal year.
IIP contracts in June primarily led by manufacturing
- Headline IIP contracted for the first time in four years in June 2017 and printed -0.1% YoY.
- Manufacturing sector showed a contraction along with capital goods and consumer durables.
- The weakness in June IIP was on broadly expected lines on the back of GST related uncertainties. The core infrastructure index for the month had also indicated a sharp slowdown.
- Consumer durables continue to contract presumably still on GST related destocking.
Significant negative contributions were made by electrical apparatus, diesel, cement, printing machinery etc. We expect some disruptions to continue while the economy adjusts to the GST implementation. Once restocking starts gaining ground we should see some improvement in IIP.
RBI MPC minutes: Growth concerns emphasised; data to dictate outlook
- The Monetary Policy Committee sounded cautious on the inflation front, with emphasis on growth downsides and the need to accommodate them.
- We believe the policy trajectory will remain data-dependent in absence of supply shocks or a significant inflation undershoot.
Indian equities started week higher. Domestic benchmark indices traded in a narrow range ahead of the CPI print for July. Market participants also kept an eye on trend in global markets, which seem to be recovering from last week's weakness. The rally was led by gains in FMCG, banking, metal and auto shares.
The rally continued for most part of the week barring last trading day of the week. Metal and energy sectors were the other major sectors, which drove the rally. Banking sectors came under pressure as minutes of RBI’s August policy subdued hopes of further rate cuts by RBI. On the global front, the de-escalating of tensions between North Korea and US is also reviving investors risk appetite.
During the week Sensex gained 1.00% to close at 31524.68 while Nifty advanced 1.29% to close at 9837.40.
Indian government bonds started this week lower as sharp rise in the WPI print for July sparked concerns of a similar rise in the CPI-based inflation. Caution in truncated trading week also kept bonds under pressure. Cautious ahead of the MPC minutes by the RBI also weighed on gilts.
Indian government bonds did not trade on Thursday as markets were closed on account of Parsi New Year.
The 10Y benchmark yield ended at 6.51% similar to previous week’s close.
Oil started this week lower by almost 1% from last weeks close. Crude prices face pressure amidst hints of rising US output as Baker Hughes reported an increase in oil rig count by 3 to a total of 768, the highest since April 2015. A slowdown seen from Chinese refining, the world’s second biggest consumer raised concerns from the demand side, but losses were capped as news of supply disruptions came from Libya amid security threats and labour dispute.
Crude prices are stuck at similar levels seen a year ago, justifying the frustration among OPEC and Non-OPEC members.
The EIA data released on Wednesday announced a fall in crude inventories by 8.95 million barrels last week, nearly three times analysts' expectations for a decrease of 3.1 million barrels. At 466.5 million barrels, crude inventories were at their lowest since January 2016. However, this did not lift spirits for the commodity as investors focused on the US crude production which jumped by 79,000 barrels per day to over 9.5 million bpd last week, its highest in more than two years.
Gold started the week in red. The yellow metal slipped by over 0.5% from last week’s close as the dollar edged slightly higher amidst high political tensions and a weaker US inflation data. The possibility of an outright military action is highly unlikely even as aggressive rhetoric continues between US and North Korea, which contained the rally for gold.
Easing of political tensions in the Korean peninsula along with strong US retail sales data buoyed the Dollar. Investors await the minutes of the latest Fed meeting in July for further cues on potential interest rate hikes, which could send gold back in the doldrums.
Bullion rallied after the minutes of Fed signaled policymakers wanted more clarity on the soft inflation trend being transitory. The yellow metal also got a boost following resignations by CEO’s from President, Mr. Trump’s business council.
Indian Rupee started the week marginally stronger. Dollar sales by a few foreign banks aided the domestic currency. Meanwhile, INR weakened marginally as foreign banks sold the greenback. Positive domestic equities however, capped losses in the rupee.
Rupee did not trade on Tuesday and Thursday as markets were closed.
Source: ICICI Bank Research, Bloomberg and CRISIL.