IIP shocker: Experts see doom, gloom and very little boom

Even though most economists had expected a dismal showing in the month of June, 1.8% contraction in the industrial production surprised one and all.

"We need to be very careful about interpreting these numbers because there are all kinds of base effects," Sajjid Chinoy, JPMorgan said. 
The manufacturing number benefits from an unfavourable base effect whereas mining, electricity actually benefit from favourable base effects, he said.
"If the month-on-month seasonally adjusted number was zero for this particular month, you would see an IIP number of about 0.7%. The fact that it is -1.8%, suggests a seasonally adjusted contraction month-on-month of about 2.5%. This means all of the gains that you saw in the May numbers have been wiped out," he told CNBC-TV18 in an interview.
"This is not really surprising for two reasons. One is if you look at new orders within the PMI, for 3 consecutive months, you have seen new orders fall. So at some point, the inventory is holding steady. You have to see the impact on production," he said.
The most worrisome number is consumer non-durables, said Chinoy.
Agreeing with Chinoy, Samiran Chakrabarty of Standard Chartered Bank said, while FY12 is a year when we were only talking about investment slowdown, FY13 will be a year when we would be talking about a consumption slowdown.
On top of that, he said, you have the monsoon effect, which will also come in. All this put together, it will be very difficult for consumer durables to sustain such high single-digit growth print.
On the capital goods side, he said, the capex cycle can pick up may not come anytime soon. All in all, he said, it's a pretty dismal picture on the industrial front. Next page: Catch the entire interview transcript.
_PAGEBREAK_ Below is an edited transcript of the economist panel interview on CNBC-TV18. Q: What do you make of the numbers? Chinoy: We need to be very careful about interpreting these numbers because there are all kinds of base effects. The manufacturing number benefits from an unfavourable base effect whereas mining, electricity actually benefit from favourable base effects. If the month-on-month seasonally adjusted number was zero for this particular month, you would see an IIP number of about 0.7%. So the fact that it is -1.8% suggests a seasonally adjusted contraction month-on-month of about 2.5%.
This means all of the gains that you saw in the May numbers have been wiped out. This is not really surprising for two reasons. One is if you look at new orders within the PMI, for 3 consecutive months, you have seen new orders fall. So at some point, the inventory is holding steady. You have to see the impact on production. But for me, the most worrisome number is consumer non-durables. We pointed this out last month as well.
For four successive months, consumer non-durables have declined or contracted month-on-month. Today's number again suggests a 1.5% contraction seasonally adjusted month-on-month. At a time when you are facing a bad monsoon, which will eventually impact consumer durables, the fact that non durables are not doing well is a significant concern, which in conjunction with the weak capital goods numbers make us believe that we are hit with a double whammy. Investment, of course, has been weak but now consumption is pretty steadily falling off as well. Q: How bad does it look to you; does it look like the bottom is not in sight? Chakrabarty: It is difficult to find the silver lining to such kind of data. So I would agree with Mr Chinoy. As I have been saying for some time, while FY12 is a year when we were only talking about investment slowdown, FY13 will be a year when we would be talking about a consumption slowdown.
We are seeing that real wages are probably becoming negative, nominal wages are falling below the inflation rate. We are seeing asset prices to be almost stable to stagnant. In this kind of a situation, it is very difficult to imagine how consumption can sustain for a long period of time.
On top of that, you have the monsoon effect which will also come in. All this put together, it will be very difficult for consumer durables to sustain such high single-digit growth print.
On the capital goods side, the challenge is that the recent RBI data shows that private corporate capex has declined in a nominal 11% decline in FY12. The pipeline also seems to be very weak. In that context, we imagine capex picking up anytime soon will not be there. So, it's a pretty dismal picture on the industrial front. Q: How would you deal as a bond dealer; does this give you a feeling at all that the RBI will move, why are people buying bonds? Vaidya: A negative IIP number always gives a reason for bond markets to cheer up, and obviously, the expectation will start building up again. The inflation growth dynamics need to be seen but at the same time, a weakening growth gives reason for people to be long on the rates - that is the reason you are seeing some buying. Q: On Q1FY13 GDP data, how exactly would you extrapolate the IIP figures into the GDP data? Chinoy: This flows in almost directly into the GDP data. We now have essentially a negative average for the quarter, which in conjunction with the fact that you are setting yourself up for a bad monsoon suggests a print, which in our view will be much below 6%. We are looking at around 5.5% print.
The fact that we have growth below 6% and core CPI inflation over 9% is worrying enough. But what's most worrying is that both these things can co-exist. The fact that corporate capex has fallen 5-6% points in GDP over the last three years suggests the potential rate of growth has fallen quite sharply. So we have to get used to living with a sub 6% growth numbers for the next few quarters.
_PAGEBREAK_ Q: How worried would you be about the GDP data?
Chakrabarty: Before this IIP print, I would have gone ahead with 5.5% GDP growth print for Q1. But it looks likely that the GDP growth number might slip below 5.5% mark because even with a pretty decent assumption on service sector growth of about 8.5%, you are unlikely to see anything above 5.5% on GDP because agriculture is unlikely to give any boost. Q: You are talking about 5.5% for Q1? Chakrabarty: Yes, because in any case, this was not going to be a quarter which was too much in doubt in terms of lower GDP. The real question mark is that the base effect turns favourable from next quarter onwards. Even the IIP growth between these two quarters has dropped from 5.7% to 3.6% last year. So whether this favourable base effect works at all in the favour of growth numbers is something which we need to see.
If that does not happen then obviously GDP growth numbers will stay very weak. The point remains that we are going to be trapped in this low growth high inflation, high interest rate environment for a significant period of time. Q: What is significant? Chakrabarty: In my view, it is at least 12 months. Q:  If this is even a month-on-month contraction, is June worse than May? Chinoy: Aggregate IIP has contracted 2.5% month-on-month seasonally adjusted, which basically gives up all the gains from the 2.5% gain the previous month. On the mining numbers, it was 0.6% YoY that still means a month-on-month contraction because if there was no month-on-month change at all then the mining number should have been 1% YoY. Both mining and electricity benefit from a very favourable base effect this month. Q: Will you trade with any expectation from the RBI at all? Vaidya: Before the policy, the market will have a tendency to anticipate a cut despite negative noises on the inflation front. Clearly, the sound bytes from the finance ministry towards the policy will again be on the dovish side. Given the fact that the data is so weak, most of the market participants would be tempted towards playing from the long side on rates.
_PAGEBREAK_ Q: What are you expecting from the RBI - do you think it is the WPI number, which will dominate in any case? Chakrabarty: I'd like to make a distinction here. RBI is saying that growth is falling. They are saying that there is an output gap that's getting created. But at the same time, they are making very strong statements repeatedly in June and July that a rate cut at this juncture is unlikely to spur growth because the supply side is not strong enough or because fiscal actions are not being taken.
If that situation continues, those pre-conditions are not met of a fiscal cleanup and supply side reforms, we might be in a situation where RBI's hands are tied, and regardless of a growth slowdown, they don't cut rates. We are working with that kind of assumption right now. We think that rate cuts are going to be back loaded. So there will be substantial amount of rate cut in 2013 but probably almost nothing in 2012. Q: There are variables which are not even in our control such as the monsoon acting up against us. How exactly do you think that we can get out of this mess of high inflation, low growth? Do you think it is just the government which will be solely responsible to bail us out now? Chinoy: I think that is a theme we have been highlighting for many months now that the efficacy of interest rates in the current environment to increase our potential rate of growth is very limited. If you speak to any entrepreneur, a 50 bps of rate cut is going to do nothing.
Instead, I think we have to recognize that to get our potential back above 7%, a lot of this is the implementation issues. It is the fact that land, environmental clearances, coal availability, more regulatory and policy certainty, the mining sector, the power sector; those are the brass tax of governance.
I keep coming back to this one statistic, which is the number of projects on the ground under implementation, which have either been stalled or abandoned is four times as high today as it was two-three years ago.
So I don't believe that magically passing FDI in multibrand retail or FDI in insurance will be any kind of silver bullet. Deep bottlenecking implementation issues on the ground over the next six months will be absolutely critical to reviving the investor momentum.
The other issue is the fiscal consolidation. If we do not take the necessary measures and subsidies, I think there is a possibility that later this year, S&P and Fitch may inclined to downgrade us. That would be a devastating outcome in terms of borrowing costs for the corporate sector.
I think the two key challenges have to be how do we keep the fiscal consolidation on track and how to we create a better environment on the ground to get the investment cycle moving. Q: You must have heard both these economists and several others telling you that there is really no pick up for credit – do you think that irrespective of what the inflation number was and what happens on September 17, bond yields cannot really rise much because there is nowhere that banks can put their money, they will have to come and buy bonds, do you see that situation? What is your range for the 10-year? Vaidya: Broadly I think yes, bonds will be the favoured asset class as far as you are not finding any other attractive asset class and that is clearly the case now. Having said that eventually we will have to be watchful of the fact that the fiscal deficit is high, so there are going to be curve plays coming into the market. So more or less you should start seeing a steepening in the curve as we approach the second half of the year. 
Importantly, the way markets behave before any rate actions, markets are very hopeful but they keep yields or asset prices under check and the moment the rate cut comes in people would want to book profits and get out. My take would be that we still should look at 8.05% to 8.30% or maybe 8% to 8.25% as the range before the policy.
I also do expect that probably there will be no action from RBI because of structural factors. I think land has yet to correct, labour has yet to correct and obviously a rate correction alone cannot drive growth in the long-term.
So given that scenario and that is what probably is the message that RBI is driving. I think post policy you should see some sort of correction and steepening of the yield curve. Q: What is the liquidity situation currently in the bond market or is the rally just fuelled by data we are receiving? Vaidya: Not really. I think the liquidity has been comfortable for some time and will continue to remain reasonably fine until the currency really comes under stress. Broadly, we are looking at a stable liquidity scenario of about 40-50000 deficit on the maximum side unless you see stress on the currency.
I think it is quite comfortable and I think RBI is also very comfortable with it. It is important that in a high inflation rate scenario, you give liquidity at a price. And that is what really RBI is trying to do, and that is probably the right thing to do.
 Q: Is 5.4% your Q1 GDP estimate? Chakrabarty: It is about 5.5% before the IIP print but I might need to relook at it with this new IIP number. Q: What are you going with? Chinoy: Government spending was quite strong in Q1 of the fiscal. So I think that will boost community and social services. But 5.5% is what we are working with for Q1 and 5.7% or 5.8% for the year depending on how severe the rainfall deficiency is.