Green shoots in economy: One-off or something has changed?

There was finally some good news on the economy on Friday. Industrial production in February did better than expected and consumer prices, while contusing to inflate, are rising at a slower pace.

The February IIP data saw output growing by 0.6 percent against market expectation of 1.7 percent contraction. More importantly, capital goods saw a 9.5 percent jump, after three months of contraction and the first robust growth in many years. However, the better piece of good news came from the March consumer price inflation. It rose by a slower 10.39 percent in March compared to 10.91 percent in February. Also, food inflation was slower than in January. Not the one to get carried away, Shubhada Rao, senior president and chief economist at YES Bank treats the buoyant IIP figure as a one-off. "So if we look at extrapolating this kind of a momentum right until the next month, which would be the year ending month, I would be surprised if the overall IIP growth for the year crosses 1 percent," she told CNBC-TV18 in an interview. But the sentiment is a lot better than what it was a year ago, agrees Keki Mistry, VC & CEO, HDFC, adding, the problem is that the investment cycle hasn’t picked up yet. “In all this gloom and doom, we keep hearing about all the time, people tend to forget the fact that what one of the biggest problems we have had over the last two or three years has been inflation. If you see the last couple of months, you will see that with the continuous decline in oil prices, hopefully, that inflation worry will become lesser and lesser one. That should put less pressure on the current account deficit and that should hopefully help the currency and help the economy in the long-term,” he told the channel. Bond markets ran up on hopes that at long last the RBI can cut rates with a firmer hand since WPI and CPI are moving lower together. Both Rao and Mistry are hopeful of rate cuts going forward. While, Mistry says whether RBI will cut rates on May 3 will be a matter of timing, Rao expects 50 basis point cut by 2013 end. Here is the edited transcript of the interview: Q: The Index of Industrial Production (IIP) numbers have beaten street expectations and yours as well. You were expecting a -1.3 number. Do you believe that this is sustainable or do you think that this is a one off? Rao: I would think it is one off because once again, the volatile component of IIP, which is obviously the capital goods index has thrown in a positive surprise, growing as much as 13.5 and not withstanding the components, whereby electricity machinery has actually grown by a whopping 70 percent. No doubt sustaining this would be a challenge. If you look across the board, the sequential momentum has been declining. So, if we look at extrapolating this kind of a momentum right until next month, which would be the year-ending month, I would be surprised if the overall IIP growth for the year crosses 1 percent. This clearly could be seen as a one off. We have seen electricity and mining showing a deep negative and the manufacturing sector was the most positive surprise. Consumer durables are in negative. So, overall, one needs to look at it more through a sequential momentum perspective rather than an annualised year-on-year headline kind of a number , which is a positive. Q: We have been seeing this talk of green shoots in the economy for the last couple of weeks now. We have seen the IIP numbers out on Friday, and there maybe a question mark on the sustainability. We are still awaiting the Q4 gross domestic product (GDP) numbers, and the government’s view is that they will look much better than what is being expected and anticipated. Do you see a perceptible difference when you speak with industry in terms of restarting of the investment cycle? Mistry: If you look at sentiment today compared to what it was say a year ago, clearly sentiments are a lot better. But having said that, we are not really seen the investment cycle start. So, it is not that people are sitting on large projects and willing to put in large amounts of capital. In all this gloom and doom that we keep hearing about all the time, people tend to forget the fact that what one of the biggest problems we have had over the last two or three years has been inflation. If you see the last couple of months, you will see that with the continuous decline in oil prices, hopefully the inflation worry will become lesser. One, that should put less pressure on the current account deficit and that should hopefully help the currency and the economy in the long-term. Q: What is it going to take for the investment cycle to pick up? Because we just talked about the pain alleviating on the inflation front, the impact of the twin deficits and the action that the government is taking on that front. But none of that seems to have impacted a turnaround as far as the investment cycle is concerned. Given the macro economic context today, do you expect an aggressive rate cut from the Reserve Bank of India (RBI) or 25 basis points, which is what the street is expecting? Mistry: My view is that rates will be cut. If we were to sit across the table and talk one year from now, we definitely will be looking at interest rates which would be lower than they are today. How much lower is tough to say – 100 basis points, 125 basis points, somewhere in that kind of vicinity. Will RBI cut rates on May 3? I think it is a matter of timing. RBI will certainly cut rates in my view in the remaining part of the year. Whether the rate cut will happen in May, whether it will be 25 basis points, whether there will be no rate cut at all, that is a matter of timing. My sense is that RBI would like to see what kind of monsoons we end up with. If we get good monsoons, then the rate cutting will be a little more aggressive and we would see much lower interest rates going forward. There are still a couple of weeks to go. They will wait to see how things pan out during this time, with the gross domestic product (GDP) numbers coming in and so on so forth, and then take a call.

Q: How much do you believe Reserve Bank of India (RBI)is going to move in terms of a rate cut? 50 bps is what industry hopes for. What is your own expectation on the repo front and also do you think the RBI will follow through with the cash reserve ratio (CRR) cut and a repo cut? Rao: Quite right. There is a wider expectation that while fiscal consolidation takes place, there is a role for monetary policy to play a complementary role and to that extent we do believe that there is room for a 50 bps cut in the calendar year up to December. We are of the opinion that it ought to get a little bit front-loaded, rather than wait another quarter or two. But nevertheless, a repo rate cut alone is not going to be sufficient to have an effective transmission. A larger concern for systemic liquidity to improve would be on the liquidity side. It could be a CRR, but our bet is more on open market operations or some liquidity adjustment in a dynamic fashion, which we could expect from the RBI. So that if a combination of a repo rate cut along with the liquidity easing measures are unleashed, then we could see some transmission through lower lending rates, perhaps as I said playing a complementary role. The lead role has to be played by the policies to revive investments on the longer front on land acquisition, resources, environment and the forest. But it is going to take us a quarter or two before we see these very concrete signs of recovery on the investment front, at least. Q: You speak with foreign and domestic investors. What are they most worried about at this point in time? Is it the political instability, regulatory concerns, lack of approvals, delay in approvals, tax concerns? What is weighing on investor sentiment when you speak with foreign investors specifically? Mistry: It is a combination of both the things that you talked about coupled with the fact that people are also a little concerned about the political situation, not knowing when the elections will be, not knowing what the next government will be. So, it is a combination of various factors which is making investor a little wary about India. We must bear in mind the fact that what attracted foreigners to India in the first instance has not gone away. India is still a very under-penetrated market, we still have a very large portion of our people who need services, goods, financial service products, and therefore the growth rates in India might be a little lower in a quarter or two but the long term growth rates of India remain intact and India will grow.