US Federal Reserve hikes rates

Indian Economic Update

India: Price pressures rise sharply; industrial growth turns tepid


Broad-based slowing in industrial production in October

Headline IIP moderated to 2.2% YoY in October from 4.1% YoY in September, in line with expectations. The slowdown was broad-based. The loss of man-days due to the festive season in October would have impacted production.

  • On a sectoral basis, mining showed a sharp deceleration to 0.2% YoY from 7.8% YoY in September, which may be partly attributed to the base effect. Similarly, output for manufacturing (to 2.5% YoY from 3.8% YoY) and electricity (to 3.2% YoY from 3.4% YoY) weakened in October as compared to the previous month.
  • On the use based classification, the sharpest slowdown in output was seen for primary goods, followed by consumer durables and non-durables. Output for consumer durables printed at a three-year low -6.9% YoY in October, probably reflecting the deleterious impact that a high GST rate on most of these goods has been having on their demand.
  • In a welcome development, the production of infrastructure and construction goods saw a sharp uptick to a 10-month high 5.2% YoY in October from 0.4% YoY in September. The output of capital goods weakened slightly in October, albeit still remaining relatively robust.
  • Positive contribution to headline IIP growth came from Digestive Enzymes and Antacids (DEA), diesel and electricity, while electric heaters and gold jewellery were the major negative contributors to the headline IIP print.

The production slowdown in October vis-à-vis September is a seasonal phenomenon, and is largely attributable to the loss of working days. The pruning of the number of items in the highest GST bracket in November should be a demand positive. Automobile production numbers for November bode well for the next print for durables, while a favourable base may aid non-durables growth. Overall, production is likely to be on an uptrend in the months ahead as one-off GST effects abate.


Sharp uptick in headline and core CPI in November

CPI inflation for the month of November was surprisingly high at 4.88% YoY as compared to our estimates of ~4.4% YoY and core inflation has also rose by ~30 bps.

Key takeaways are as follows:

  • Food inflation has risen sharply in November by 1.4% MoM, which is unexpected at this time of the year. Most food groups including meat, eggs, vegetables, sugar etc. have risen sharply.
  • We had expected some moderation in core components and expected some indication of pass through of extensive GST rate cuts initiated in mid-November. However, core inflation was sharply higher with increases in health, education, transport and household goods.
  • Estimation of trajectory for inflation going ahead has become fairly uncertain and has also led to significant dispersion in market estimates.
  • Housing inflation however seems to have moderated a bit and was lower than expected.
  • On the back of this outcome for November CPI, it is likely that the next few prints till the end of this fiscal year would come in more than 5% YoY ending March at ~5.3% YoY.

We note here that the RBI has recently revised its CPI forecast for H2 FY2018 to 4.3-4.7% YoY. Till October, H2 CPI was tracking this range but the November outturn has effectively negated this range. If the inflation trajectory has to show any meaningful recovery from these levels then we would require substantial declines in most components such as food, miscellaneous and clothing and footwear.


External sector vulnerability remains low amid robust FDI flows

  • Current account deficit came in lower in Q2 FY2018 as compared to Q1 on narrow trade deficit. Income related outflows needs to be closely watched.
  • Capital flows were supported by strong FDI inflows while portfolio flows were muted. Continuation of strong FDI flows reflect favourable growth outlook.
  • Current account deficit expected to worsen to ~1.8% of the GDP in FY2018 as against 0.7% of the GDP in FY2017. The trend is expected to further worsen in FY2019.


Other important developments during the week:

  • The provisional figures of direct tax collections up to November 2017 show that net collections are at INR 4.8 tn which is 14.4% higher than the net collections for the corresponding period of last year.
  • Wholesale price inflation accelerated to 8-month high of 3.93% YoY in November due to a sharp rise in onion prices and costlier seasonal vegetables. WPI core inflation rate came in at 3.0% YoY.
  • Exit polls predicted a victory for the Mr. Narendra Modi-led Bharatiya Janata Party in Gujarat, giving it a clear majority in assembly polls in the state. The polls also showed that the party is set to reclaim Himachal Pradesh.

Global Update

US: Subdued wage growth and increased employment in November

  • US Non-Farm Payrolls (NFP) increased by 228K in November compared to 244K in October.
  • Unemployment continued to stay at historic lows at 4.1%.
  • Average hourly earnings printed at 2.5% YoY lower than market expectation of 2.7% YoY.


UK and EU announced that Brexit talks can move on to the issue of future trade after the DUP agreed to amendments over the issue of the Irish border

  • The agreement added that EU citizens in the UK and UK citizens in the rest of the EU have the right to stay.
  • There is no figure on how much the UK is expected to pay but the document sets out how the bill will be calculated (expected to be about GBP 50 bn).


US: Federal Reserve hikes rates; growth revised upwards

  • In line with our expectations, the Federal Reserve hiked federal funds target range to 1.25%-1.50%.
  • The median Fed Funds Rate is unchanged for 2018 and 2019, however, the dot plot shows downward revision of rate projection by one member. The median FFR for 2020 is increased to 3.125% from 2.875% in June.
  • GDP growth projections were revised significantly upwards while that of inflation retained at earlier levels for upcoming years.


Future rate hikes will be influenced by data and tax reforms

The Fed continues to see 3 rate hikes in 2018 but evolving inflation trajectory will be important. The Congress reached a deal about possible reform sin the tax bill and the impact of this on both growth and inflation will be important for monetary policy. Given that the FOMC’s base case seems to be that factors leading to low inflation are more likely to be transitory and that US growth remains on a robust footing, we continue to expect three rate hikes from the FOMC in 2018.


UK: Bank of England maintains status quo

  • Bank of England kept its policy rate unchanged at 0.5% in a unanimous decision.
  • Asset Purchase Facility (APF) kept unchanged at GBP 435 bn, voted 9-0.
  • We expect Sterling to remain broadly supported as Brexit talks gain traction.


ECB: Maintains status quo on the policy rate; broad trend dovish

  • European Central Bank (ECB) maintained the accommodative stance and left policy rate unchanged.
  • The ECB has revised the growth forecast significantly while the overall trend in inflation is expected to remain muted.
  • Euro expected to trade in the range of 1.15 – 1.20 against US Dollar in the medium term.


Other important developments during the week:

  • US’ Republicans in both Senate and House have come to an agreement on a tax reform deal, which puts the corporate tax at 21% and highest income tax at 37%. The bill is likely to go for a vote as early as Monday.


Indian equities started the week on a positive note. The recovery in the global equity markets aided the Indian indices. Further, markets also got a boost as investors resorted to value buying after past week’s minor correction. The overall sentiment remains buoyant ahead of the crucial Gujarat election results. Some traders remained cautious ahead of India’s inflation and IIP data release.

Meanwhile, equities traded lower following weak cues from Asian equity peers. Traders also refrained from taking large positions ahead of the release of India’s inflation and IIP prints. The surge in bond yields and increase in key commodity prices have led to fears of rising input costs for firms.

Equities gained towards the end of the week. While, Wholesale Price Index rising to an eight month high of 3.9% YoY in November from 3.6% YoY a month ago weighed on investor sentiment. Further, J & K Finance Minister, Mr. Drabu suggesting further rationalisation of items in the 28% tax slab buoyed investor sentiment.


During the week Sensex gained 0.64% to close at 33462.97 while Nifty advanced 0.65% to close at 10333.25.


Indian government bonds started the week significantly lower. Bond prices went down as traders resorted to selling in anticipation of higher than expected November CPI print. Probability of a fiscal slippage and increasing inflation put bond prices under pressure. Market sentiment got hit as oil prices surged to two year highs.


Gilts recouped some of their losses on value buying. Sentiment remains weak after a rise in November CPI inflation rate. Bonds got a boost following Federal Reserve’s dovish guidance. The fall in oil prices from the two year peaks hit also supported Indian bonds. The sharp increase in WPI weighed on trader sentiment. Government’s decision to purchase INR 200 bn helped to lift the investor sentiment.


The 10Y benchmark yield ended at 7.11% as compared to the previous week’s close of 7.09%.


Oil started the week on a mixed note, Oil prices were weighed down by fears of rising US production as US drillers boosted the rig count by two to 751, a three-month high, according to Baker Hughes data last week. Also putting pressure on prices were comments from the Kuwait Oil Minister, Mr. Issam Almarzooq on Sunday who stated that the OPEC-led output curbs may end earlier than scheduled if the market re-balances by June.

Oil prices gained amid the Forties North Sea pipeline shutdown. The outage raised the prospect of a supply shortfall and comes as the global oil market has already become tighter following nearly a year of production cuts by the OPEC and other major producers.

EIA in its monthly short-term energy outlook, revised the US crude oil output growth by 60,000 bpd to 10.02 million bpd in 2018 from its last month’s forecast of an expected output of 9.95 million bpd next year. OPEC crude oil supply fell in November for the fourth straight month, to 32.36 million bpd on the back of lower output and overall higher compliance with the accord.


Gold edged up marginally during beginning of the week as a weaker Dollar supported prices but expectations of an increase in interest rates in the United States kept the metal from gaining any sizable traction. After hitting its lowest levels in nearly 5 months the yellow metal picked up marginally, but continued to remain under pressure due to strong equity markets and prospects of short-term Dollar strength.


Investors looked past an upset win by a Democrat candidate in a deeply Republican state of Alabama, as a modestly supported Dollar on upbeat US PPI print prompted some fresh selling around the yellow metal.


India Rupee opened the week on a stronger note. Dollar sales by foreign banks and positive performance of domestic equities supported the local currency. However, Dollar purchases by public sector banks pared Rupee’s further appreciation.

Meanwhile, importers' Dollar buying weighed on the domestic currency. Dollar sales by some foreign banks supported the INR. US Fed’s dovish outlook following rate hike weighed on the Dollar index, in turn aiding domestic currency. The positive performance of domestic equities also supported the Rupee.


Source: ICICI Bank Research, Bloomberg and CRISIL.