India’s economic growth has picked up above 5% in the last couple of quarters. The new government promised economic reforms to improve the investment climate. It has already made some progress such as: ending diesel price subsidies, implementing reforms in the labour market, passing a long-awaited insurance bill, encouraging greater private participation in coal production and financial sector reforms. These changes will be driven by:
Easing inflation. The economy has also received a significant and unexpected boost from falling commodity prices positively impacting inflation. Terms of trade. The terms of trade in India decreased to 60.20 index points in 2014 from 61.90 index points in 2013. The terms of trade in India averaged 81.41 index points from 2000 until 2014, reaching an all-time high of 100 index points in 2000 and a record low of 60.20 index points in 2014. Monetary Policy. Despite the sharp fall in inflation in recent months and pressure from the government and businesses, the Reserve Bank of India (RBI) did not cut the policy rate at its meeting on 2 December.
The weakness in the IP index in October is extremely disappointing, particularly given that many factors, including the stronger PMI and strong core-sector growth pointed to the probable expansion of industrial activity during the month. Combined with fresh positive consumer price inflation data showing consumer price index inflation easing to 4.4% y-o-y in November, the latest industrial output reading makes an even stronger case for the RBI to start easing monetary policy in the next few months. But manufacturing activity momentum accelerated to a two-year high in December, led by a healthy increase in new domestic orders as well as from abroad.
India’s November trade deficit widened to $16.8 billion from $13.3 billion in October, as an increase of gold and non-oil, non-gold imports more than fully offset the impact of lower oil prices. Both these dynamics played out: oil imports dropped to $11.7 billion from $12.4 billion in October. The first surprise was that gold and silver imports surged further from $4.9 billion in October to $6.3 billion in November. The rise in imports of primary and intermediary goods mainly used in production is encouraging, particularly given the latest abysmal industrial production data that showed India's industry output shrinking 4.2% y-o-y in October, with its manufacturing component declining 7.6%. However, as these numbers are still preliminary, it is still too soon to declare a recovery in investment and manufacturing, with the latter expected to continue showing uneven performance from month to month.
November trade data follows last week's balance of payments release, which showed India's current account deficit to have widened to 2.1% of GDP in July–September, up from 1.7% in the previous quarter. Although gold imports remain a concern, it seems the current account deficit will remain below the government's threshold of 2.5% of GDP in 2014 and 2015. The other surprise was a 14.1% m-o-m seasonally adjusted spike in non-oil, non-gold imports, pushing trend growth to 26.2% y-o-y. This sharp bounce and other high frequency data for November – notably auto production, credit growth, and the manufacturing and services PMIs – suggest that domestic demand may be firming, in contrast to the weakness of October’s industrial production. That said, strong non-oil, non-gold import growth over the past few months could be attributed, in part, to the 9% appreciation of the real rupee exchange rate over the last year, on strong capital inflows and a large balance of payments surplus.
Exports in India increased to $26.0 billion in November from $25.3 billion in October. Imports in India also increased to $42.8 billion in November from $39.3 billion in October. Imports increased 26.79% y-o-y, driven by a 5.6 times jump in gold purchases.
India recorded a trade deficit of $16.9 billion in November, the highest trade gap in eighteen months. Indian goods producers ended 2014 in high gear with business conditions improving at their quickest pace in two years in December. The accelerated growth of the manufacturing sector was reflected by faster expansions in output, new business and foreign orders. The latest data also painted a brighter picture in terms of prices, as inflationary pressures eased during the month.
India’s PMI climbed to a two-year high of 54.5 in December, up from 53.3 in the prior month. Business conditions improved at a faster pace during the month, with the sharpest expansion seen in consumer goods. The latest data reflected reports of improving demand in December, as new orders increased for the fourteenth consecutive month. Moreover, the rate of expansion was marked overall and was the fastest since the end of 2012. Reflective of further growth of output and new orders, input buying among Indian goods producers increased in December. The rate of expansion accelerated to the highest level in the current 14-month sequence of growth. Subsequently, the pace of pre-production inventory building picked up to the sharpest level in more than two years. Furthermore, stocks of finished goods held by Indian manufacturers rose at their fastest rate since the survey began in April 2005. Meanwhile, contrasting with continued growth of production and incoming new work, staffing levels in India’s manufacturing economy declined in December. That followed two successive months of slight job creation, although the pace of contraction was a fraction overall. Job losses were evident in two of the three surveyed sub-sectors, with the sole exception being intermediate goods.
Inflation is expected to remain within the 6.0-6.5% target range over next five years, well below the double-digit rates seen over the past few years. Lower inflation should support domestic demand and encourage investment. Both the wholesale price index (WPI) and the consumer price index (CPI) inflation measures fell to a five-year low in October as a result of lower prices for food and fuel. Moreover, since then, global oil prices have continued to fall and are now expected to stay relatively low for a prolonged period. With favourable base effects tapering off from December onwards, the November CPI inflation reading may end the moderating trend, and December’s CPI is likely to show a mild uptick in inflation. However, the underlying factors should continue to remain favourable, largely reflecting softer global oil prices, sufficient food supply and still weak domestic demand.
Coupled with a recent shocking industrial production data showing India's industrial output having tanked 4.2% y-o-y in October, the fresh CPI reading makes an even stronger case for the RBI to start easing monetary policy in early 2015. With a larger share of oil in the wholesale price basket (fuel and power alone account for 15% here, as opposed to 11% in the consumer basket), it is no surprise that WPI inflation is moderating faster than the CPI. The data shows soft global oil prices over the previous months and has moved India's WPI into a deflationary territory in November. Following better than expected November inflation readings (both wholesale and retail), the December inflation data may be critical for the RBI's decision on future monetary policy stance. The RBI's governor, R. Rajan, kept the leading repurchase rate unchanged at 8% in November, hinting at possible rate cuts early in 2015. However, should December’s inflation continue to moderate despite the dissipating favourable base effects, the RBI may act outside the policy review cycle, cutting rates as soon as mid- January 2015. The GDP growth expectation remains unchanged at 5.5% in 2014 and 5.8% in 2015.