August 2011

1st August 2011
Indian Economy Next Quarter
Expect another 100 bps hike in rates by March
Rate hikes will hit manufacturing more, service sector to continue strong, construction already slowing down
Rupee set to appreciate over next quarter
Export growth to moderate over the year
Inflation set to fall by December, manufacturing inflation to touch 5% by year-end
India : Kal, aaj aur kal

The RBI did it again, after putting in a sense of stability with calibrated hikes over the past year, there have now been two 50 bps hikes as surprises since April. It has also made very clear that it now wants to reduce growth to address the inflation problem. We don?t agree, but these are grey areas at best, and there are very strong arguments on either side.

On the one hand the WPI is expected to touch 10% levels this month, trending slowly towards 6.7% by March if we are lucky. Since the message has gone home quite clearly this time round and since manufactured products inflation is expected to move to 5% levels only by April, another 100 bps of rate hikes seems to be on the cards by March.

What does this tight policy actually mean for the economy? We have said before, the rate hike will do little to stem inflation, the pressures are coming in from primary inputs, food and fuel. The RBI knows this, which is why it has kept rate hikes moderate so far. With supply constraints not easing, thanks in large part to government policy, the strategy is now to hit on the demand side through high rates, effectively dampen growth, and through that hope that inflation eases. The problem with this kind of strategy is that the long term impact is much more serious than what will happen in the short term.

So far while investment rates have already fallen in Jan-March, current data show that apart from auto sales and IIP numbers, all other indicators appear fairly impervious to the rate hikes. PMI manufacturing is lower, but service sector PMI still high, exports are up, non-oil imports are up, growth in non-food credit has fallen just marginally. A large part of the economy therefore seems to be taking the rate hikes in its stride. Also, tax refunds of more than Rs. 46,000 crores for the last quarter will definitely add to the demand equation, and to the fiscal risks with higher borrowings.

The question that is on top of our mind is what if the growth slowdown does not materialise as the RBI desires? And how much longer will the foot be on the pedal? The RBI appears quite emphatic about pressing till inflation in manufactured products begins to show signs of moving steadily downwards to the long term average of 4%, which can be seen as a target. We do hope that the slowdown does show up sufficiently in the data very soon, because the alternative will be very painful for the long term. For the time being however, apart from some minor indications from automobile and real estate sectors, the only indication is of an investment slowdown not a growth slowdown. In other words, one thing that is certain is that 8%+ growth would be difficult to achieve next year onwards due to the dramatic fall in investment growth.

And then there are the added risks lurking on the global front, if these risks materialise, the tight policy in India can hurt much more than intended. What is the alternative though? It is interesting that the RBI has now gone all out on the government, saying what we have been saying for a long time ? the bank has to raise rates and will have to continue to do so, essentially because of lack of support from the government. The growth momentum in the economy is very strong, giving substantial kick to demand; the frustration of the bank bearing the sole responsibility for inflation is now showing up as government inaction gets magnified.

It?s all fine for the RBI to suggest that the government shift from revenue to capital expenditure and build in the requisite infrastructure? the list is long and well known. There is barely any action on the horizon here. So unfortunately, the way things are playing out, what will happen is that the economy will take the hit where it hurts the most, its long term growth potential - a sad twist to the India story.

Sumita Kale and Laveesh Bhandari

1st August 2011, Indicus Analytics

Sumita Kale is Chief Economist, and Laveesh Bhandari is Director, Indicus Analytics. They can be contacted at This email address is being protected from spambots. You need JavaScript enabled to view it. and This email address is being protected from spambots. You need JavaScript enabled to view it.

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Economic Growth
PM?s Economic Advisory Council drops growth forecast for 2010-11 to 8.2%.
IIP for May grew by 5.6% over the previous year, with mining, manufacturing and electricity sectors growing by 1.4%, 5.6% and 10.3% respectively.
The eight core industries grew by 5.2% in June over the previous year, steel output expanded by 12.5% and electricity by 8.2%
Electricity generation grew by 12.49% in July over the previous year, according to provisional estimates by the CEA.
Non-food gross bank credit increased by 19.6% in June compared to 20.2% growth last year. Credit to agriculture on a y-o-y basis increased by 12.8%, to industry by 22.2% and to the services sector by 20.9%.
HSBC Markit PMI for manufacturing fell again, to 53.6 points from 55.3 in June, growth was at a 20 month low, with new orders contracting for the first time since May 2009.
For the services sector, the HSBC Markit PMI rose again in July to 58.2, showing resilience.
Passenger vehicle sales in the domestic market recorded their sharpest drop in over three years last month. Sales were lower for 12 of the 19 automobile manufacturers by 10.56% in July,, the first time that sales went into the negative zone in the last 27 months. Two-wheeler sales rose by 13%
With rainfall 1% below the long term average, sowing till 22nd July has been less than last year, with food grain sowing lower by 19.8% and oilseeds down by 0.7%. However, with the resumption in rains at the end of July, sowing has now picked pace again. Monsoon pattern in August will hold key to kharif output prospects.
Read:India: how low can growth go?
Read:Despite rate hike, manufacturing resilient
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Inflation
Provisional WPI inflation for June estimated at 9.44%, with manufacturing products inflation at 7.4%.
While inflation in food articles has trended down and at 8.38% in June is half the level of January, oilseeds and minerals have shown steep rises. Within manufactured products, inflation has been much higher in edible oils, iron and semis than January levels.
Consumer prices rose by 8.62% in June for CPI IW and 9.32% for CPI AL.
The crude basket for India rose to $112.37 in July from $ 109.85 in June. The EIA forecasts that WTI spot prices, which averaged $79 per barrel in 2010, will average $98 per barrel in 2011 and $103 per barrel in 2012.
Read: India?s two front inflation war
 
Interest Rates
The RBI hikes rates by 50 bps in its July end review, the repo now stands at 8.0% and a tight policy has been indicated in the face of persistent inflation.
Yield on the 10 year gilt rose to touch 8.4611% on the last day in July.
While in Asia, rates are being hiked as inflation continues to be a concern, the Western economies are plagued with debt crises - the US staved off a crisis for now and Greece was bailed out by stronger Germany.
Read: Hope is not a plan
Read: Asian currencies advance on chance of interest rate rises
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Exchange Rates
Exports during June were valued at US $ 29213.14 million, 46.45 % higher in $ terms than last year while imports were valued at US $ 36872.49 million, up 42.46 % in $ terms over last year.
Oil imports during June were valued at US $ 10180.1 million, 30.09 % higher than last year, and non-oil imports were estimated at US $ 26692.4 million, 47.82 % higher than last year.
The trade deficit for April-June 2011 was estimated at US $ 31610.06 million, lower than the deficit of US $ 26981.44 million during the corresponding quarter last year.
The rupee ranged between 43.9485 to 44.6878 during the month of July, continuing the slow appreciation since February.
Read: Betting on a range bound rupee
Read: Better late than never may not work with India commodity exports
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