The Indian economy grew rapidly in 2Q14, up 5.7% from a year earlier. Industrial production improved, with manufacturing output rising by 3.5% on the year after falling in the previous two quarters. Trade contributed positively as exports rose, while imports remained restricted. Despite the growth upgrade, India continues to struggle with serious underlying problems. High inflation and relatively tight monetary policy will dampen domestic demand, while private and government investments will be further hindered by high corporate indebtedness and a wide fiscal deficit. The growth forecasts for 2014 and 2015 remain unchanged at 5.5% and 5.8%, respectively. Although it is still early to judge whether the longer-term outlook will also see improvement, it seems that the increased business confidence resulting from the election of the new government may have boosted activity.
Indian industrial output expanded at the slowest pace in four months, with industrial production (IP) increasing just 0.98% y-o-y (seasonally adjusted by Haver Analytics) in July, down from an upwardly revised 3.5% y-o-y for June. IP disappointed for a second straight month in July, well below expectations, and it seems that 3Q growth is also off to a weak start. At least the weakness in IP was met with weaker inflation, taking some pressure off the Reserve Bank of India (RBI) to raise interest rates in order to meet its goal of 8% inflation by January 2015. However, the full impact of the dry monsoon season on food prices has not yet become evident, and recent conflicts in the Middle East could cause spikes in oil prices, leaving the inflation outlook exposed to significant upside risks. It seems the retreat in IP was greater than had been anticipated and is disappointing after the rebound seen during the period from April to June, which supported the quarter's strong GDP reading.
The mining and electricity sectors continued to expand in July, rising 2.9% and 12.1% y-o-y, respectively, but manufacturing contracted 1.0% y-o-y in July after expanding 2.5% y-o-y in June. The use-based breakdown of the IP index showed that capital goods output recorded the largest turnaround as it contracted 3.8% y-o-y in July after expanding 23.3% y-o-y in June.
Operating conditions in the Indian manufacturing sector improved for the eleventh month in succession in September, although the pace of growth weakened to the slowest since December 2013. This was matched by slowdowns in output and new order growth, while cost pressures eased during the latest survey period. India’s PMI, a composite gauge designed to give a single-figure snapshot of manufacturing business conditions, dropped from 52.4 in August to 51.0 in September. The reading was indicative of a modest improvement in operating conditions. Overall, intermediate goods were the best performing among the three monitored sub-sectors.
India's consumer price index (CPI) meanwhile recorded a more favourable result in August with inflation easing back to 7.8% y-o-y from July's reading of 8.0% y-o-y, in line with market expectations. Supporting the improvement was an easing in the food, beverages and tobacco sub-index of the CPI to 7.0% y-o-y in August, from 7.4% y-o-y in July. Consequently, y-o-y food inflation remained stubborn at 9.2% versus 9.1% in July. It seems that if current trends continue, the September CPI could decline dramatically to 7% or lower. This, in conjunction with the late recovery of the monsoon and softening global commodity prices, prompts a shift in the RBI’s call for a hike in 1Q15 from 4Q14. In contrast to the rise in food prices, commodity prices softened in August. Fuel/light and transport/communication costs, which reflect the impact of international oil prices, declined 0.2% and 0.1% m-o-m, seasonally adjusted, respectively.
India’s annual wholesale price inflation (WPI) rate fell from 5.2% in July to 3.7% in August, its lowest level since October 2009, due to base effects, the fall in global oil prices and some easing in food price inflation. However, this has yet to translate into a significant fall in CPI inflation, the most relevant price measure for households, as this only edged down from 8% to 7.8% in August. Consumer spending growth will remain under pressure until CPI inflation has moderated to around 6%. Although the RBI has lately focused more on consumer prices than on wholesale prices when assessing inflationary pressures in the economy and deciding on a course for monetary policy, wholesale price inflation is still a very relevant indicator, not least because it gives clues as to the intensity of pipeline inflationary pressures from a supply standpoint. If sustained, and especially if food wholesale inflation remains tame in coming months despite the weak monsoon season, there is a better chance that consumer price inflation would also sustain its recent easing. The RBI is targeting CPI inflation at or below 8% by January 2015. Given the stubbornly high rate of CPI inflation over the last five years despite the significant slowdown in growth, the RBI will want to see a downward trend in inflation established before easing policy. As a result, Indian interest rates are not forecast to be cut before the beginning of 2015. It seems that high interest rates are damaging growth by encouraging consumers to save rather than spend and discouraging businesses from borrowing to invest, and will continue to check domestic demand. Despite the growth upgrade, India continues to struggle with serious underlying problems. High inflation and relatively tight monetary policy will dampen domestic demand, while private and government investment will be further hindered by high corporate indebtedness and a wide fiscal deficit.