Upbeat Jan IIP, dismal CPI: Where does this leave RBI?

Beating estimates, the Index of Industrial Production (IIP) for January was recorded at 2.4 percent and economists believe the number signals bottoming out of slowdown in growth for the industrial segment. Samiran Chakrabarty of Standard Chartered Bank feels the number suggests a nascent recovery in industrial production. However, the CPI number of 10.9 percent seems to have counteracted any positive news coming out of the IIP figure, he opined.

Chakrabarty explained, "It is probably one of those green shoots which will be cited as an example of things turning around. I think most of the positive news coming out of that IIP number has been counteracted by the CPI number being at 10.9 percent. This number is not only very high, but also rising month after month and clearly would be a bigger worry from the Reserve Bank of India's (RBI) perspective."
Ahead of the Reserve Bank of India's monetary policy review on March 19, a dismal inflation reading will restrict the room for rate cuts, believes Indranil Pan of Kotak Mahindra Bank. Besides, Pan thinks rural income will continue to look up. "Given that the CPI also has come up with large increases in the food side, especially vegetables and cereals, I would like to believe that the rural income would continue to be on the higher side. That is possibly pushing up the consumer goods segment to a certain extent," Pan added. Here is the edited transcript of the interview on CNBC-TV18. Q: The Index of Industrial Production (IIP) number for January came at 2.4 percent and the consumer price index (CPI) number coming in at 10.9 percent, together does this make the Reserve Bank of India (RBI’s) task difficult? Chakrabarty: The IIP number at 2.4 percent is indicating that there is some industrial recovery, probably a very nascent one taking place. It is probably one of those green shoots which will be cited as some example of things turning around. Having said that, I think most of the positive news coming out of that IIP number has been counteracted by the CPI number being at 10.9 percent. This number is not only very high, but also rising month after month and clearly would be a bigger worry from the Reserve Bank of India’s (RBI) perspective.
In my view, RBI would have to make this fine balance between using the Wholesale Price Index (WPI) and the CPI, which are currently going in opposite directions. We will have to wait for the March 2014 data on WPI to see whether these opposing directions still continue or not. We are of the view that with some lag, the CPI numbers should start tracking the WPI numbers as well. If it does not happen, then we have to approach the inflation problem in a different fashion. It would mean the retail margins are being very sticky because of institutional peculiarities and that cannot be addressed by simple monetary policy measures. Q: Where does this leave the RBI now on March 19, would the WPI swing or will they have to worry about a near 11 percent inflation which cannot be ignored? Pan: It is a very tightrope walk for the RBI but, I would be leaning more towards the inflation reading, especially the CPI reading. What the RBI really needs to bother about at this point in time also is the downside implications for the higher aggregate demand and the higher inflation on the financial savings of the households in India. If they cannot push the financial savings on the higher side, it is very difficult to see corrections even on the current account deficit (CAD) side which will to a large extent constraint the room for the RBI for cutting the repo rate.
On the industrial production side, the clear belief that we had that industrial production is bottoming out to a certain extent, given that the CPI also has come up with large increases in the food side, especially vegetables and cereals I would like to believe that the rural income continue to be on the higher side. That is possibly pushing up the consumer goods segment to a certain extent.
As we all know, the capital goods segment will continue to struggle for some more time simply because the visibility in terms of demand is lacking and it is likely to constrain the investment demand in the economy. Overall, the RBI would still possibly lean towards a rate cut having looked at the WPI. But, definitely the room for RBI continues to get limited and restricted.
_PAGEBREAK_ Q: Would you really believe that investment is picking up and perhaps growth has bottomed out in terms of this industrial data that you are reading because the auto sales numbers don't give you that confidence? Chakrabarty: We are still in a period where we are getting mixed data signals from different indicators. It is quite likely because the decline in growth has been very-very sharp over the last one and half years. We can have a slightly flattish bottom for a while before we start moving up. In that sense, we are in that bottom period where one will get one data point to be good and the next one to be bad.
We will have to go through this period for a while but, the good news is that we are not declining any further, we have arrested the fall. To that extent, this IIP number is signalling a positive trend only. If this trend continues, then by the end of March we are probably going to see a number in the range of about 2.5-3 percent on IIP.
Maybe next year we should move into a slightly better set of numbers on the back of base effect and the fact that if there is this kind of an export recovery that we have seen in January and February continues, then given the fact that a large part of manufacturing is for export purposes, there could be an improvement in IIP as well. Q: Would you want to make a guess on the gross domestic products (GDP) number for the fourth quarter considering that we seem to have seen already the worst of the IIP behind us? Would the fourth quarter GDP be a good deal better than the third quarter number? Chakrabarty: The conventional wisdom is to say that the first half GDP was 5.4 percent average, full year average is 5 percent and therefore, the second half average needs to be much lower than 5 percent. I think there is problem with the way of looking at things because the first half GDP itself will be significantly revised downwards when the FY12 numbers will be changed.
That is why I think that when the final numbers will be out on a quarterly basis, one will probably see that in the second half both the quarters might actually look better than the first half quarters. The joker in the pack really is to what extent the fourth quarter GDP is going to be impacted by the drastic cut in planned expenditure by the government.
So if we see that component shaves off a good 0.2-0.3 percent of GDP, then probably even the fourth quarter will be quite close to the third quarter. Otherwise, we are going to see a print which is more likely to be above 5 percent. Q: Actually we have a good base effect for Q4. Last year Q4 was 5.3 percent so the base should help somewhat as well. We are seeing the industrial print coming in at 2.4 percent, therefore I was wondering whether you would even give a 5.5 percent for Q4 or not yet? Chakrabarty: Probably just because of the reason that there would be a fiscal contraction effect that will come in due to a cut in planned expenditure, we will probably see a print which is higher than 5 percent but may not touch 5.5 percent. We still have a month to go and that is a very critical month because March is probably the most productive month of the year. We need to see how that month pans out as well. Q: One of the reasons why the IIP has rebounded so much on a month on month basis is on account of consumer goods. In December it was down to 4.2 percent degrowth, the lowest levels since March of 2009 and this month it has shown a growth of about 2.8 percent. How would you read consumer goods and what would be the trend over there? Pan: I think consumer goods also to a certain extent is a bottoming out story. We have been seeing consumer goods in terms of the expenditure on the GDP that has contracted over the last four quarters and given the fact, if I really look at the rural wage story, if I look at the urban wage story, everything seems to be positive in terms of wage growth. Even the real wage growth has been quite firm, especially in the rural segment.
Having said that, therefore we are not really expecting any further erosion in consumption demand. The consumption demand should actually bottom out and may turn up. But, the extent of the turn is something that needs to be debated at this point in time. The extent of the turn to a certain extent depends on what is the type of stability that appears in terms of the inflation trajectory, in terms of the global issues and therefore, the capital flows issues and hence, the impact of that on the asset markets in India.
All this will basically determine the consumer demand story in India. As of now, we are firmly at the bottom and there is definitely a bit of an upturn that we are seeing on the basis of which the GDP numbers for the next year is likely to be better. On the basis of the assumption however, the investment demand continues to lag significantly.
_PAGEBREAK_ Q: What are you running with for the fourth quarter in terms of GDP at the moment? Pan: Overall, I am not expecting a significantly better number in the fourth quarter compared to the 4.5 percent that we saw. It is simply because there has been a significant amount of fiscal drag that was there from the government of India. That itself could restrain the fourth quarter GDP numbers.
Overall, for the year as a whole, I am looking at 5.1 percent GDP growth and that could be bouncing upwards to 5.7 percent which is again lower than 6.1 percent base line that the government is looking at. Q: Your expectations for March-April consumer price index (CPI) figures? Chakrabarty: If one looks at the CPI trend, it is quite clear that food prices are becoming very sticky. The anecdotal evidence was that food prices probably declined in February, particularly vegetable prices compared to January. But, looking at the February print, the year over year number does not look like this has happened. In that sense, we need to really investigate further as to why is it that while food price trends are probably on a declining path on wholesale price index (WPI), CPI is not reflecting a similar trend on food prices? That would probably give us a better sense of how March and April numbers are going to pan out.
 
As of now, it looks like it will stay in double digits only because there is no fresh sign of food prices declining in March compared to February. Q: What are you expecting on the WPI on Thursday and at this moment how would you see the RBI acting on March 19? Chakrabarty: We are looking at 6.7 percent on WPI if the diesel price effect fully comes in, including the effect of the bulk sales. If that does not come in, then we are probably around the 6.5 percent mark. Overall, we see a flattish trend in WPI compared to the January print.
For RBI, it is a difficult situation because WPI, lower GDP growth and the promise of fiscal consolidation will favour a rate cut. However at the same time, high CPI and high CAD pose challenges for them. The trade data for February has been positive. Therefore, in some sense you can say that even that is supporting a rate cut view. Overall, we are going with a 25 bps rate cut for the March policy but, it is going to be a close call. Q: What are you expecting on the WPI on Thursday and at this moment how would you see the RBI acting on March 19? Pan: More or less the same factors that Samiran pointed out. I would indicate a 25 bps rate cut in March. However, for me, the RBI would be tilting towards a rate cut rather than a pause. So it is not really a close call for the RBI simply because they must be realizing that just a 25 bps cut and no trajectory after that would also be losing the benefit of that 25 bps that they did. This is not the time when you actually lose benefit of a policy action.
When they did the 25 bps last time, they definitely had a bit of a trajectory in mind and therefore they would continue with a series of 25 bps cut on March 19 and possibly the last one could be on May 3. But, they would definitely have a bit of a series on the repo rate.
For me, the bigger dilemma for the RBI could actually be the CRR because in no sense of the term that we are looking at liquidity improving in a very significant way. The advance taxes are coming and if I remember the last time, the advance taxes fear had led them to cutting the CRR by 75 bps. So whether they would actually go ahead and do another 25 bps CRR is something that could be a close call for the RBI rather than the repo rate. Q: So it is not an either or, you are expecting a CRR and a repo rate possibly on March 19? Pan: A repo is definite, a CRR is a question. I would personally prefer that they don't do the CRR immediately because a lot of this is frictional liquidity deficit with the government not having spent a significant amount, the spending has actually started now. By April, when the government expenditures would tend to increase, the liquidity deficit could be in a manageable Rs 40,000-50,000 crore negative.