Is inflation finally conquered? Experts analyse

Below is the verbatim transcript of Sajjid Chinoy and Dr. Pronab Sen's interview:

Q: Is Index of Industrial Production (IIP) as bad as it looks? After all October was a month when we had a lot of holidays, I mean the Dussehra holidays came in and then there were some election holidays in Maharashtra and the Diwali holidays?

Chinoy: Ironically, what worried me yesterday a little bit more was the consumer price index (CPI) numbers not the IIP number. The IIP had lots of one offs. For starters IIP is notoriously volatile don't be surprised if two months later this number is revised up substantially. However, there were two specific one offs that should not be a concerned one is just a working days issue. This is what happened when US weather was very adverse a year ago. The number of working days is almost 15 percent less than the month before and therefore you will have lower production.

There was another on off which is a large factory in the consumer durable sector actually close shop and there would be some sequential decrease because of that. So, I would not worry too much about the October number; if you look at the high frequency data in November you see auto production has increased ten percent sequentially on a seasonally adjusted basis. The November purchasing managers index (PMI) was at the 21 month high the manufacturing PMI, the services PMI was at a 6 month high so I think October was aberration you will see the November numbers bounce back.

For me the concern was that the headline CPI number was very good. There is good news in lower food prices and lower oil prices but if you look at the month-on-month a seasonally adjusted momentum of core this is the second consecutive month that the number has gone up a lot. It went up 0.7 percent in October, it went 0.5 percent in November and it will strip out the impact of petrol and diesel which is part of core given the way it is defined. The numbers get even more soberry it is o.7 for last month and 0.8 this month. I guess it adds up to that fact there is something up in demand.

Q: Which elements in the core are rising?

Chinoy: It is essentially across the board. If you look at housing for example, if you look at personal requisite; so only transport and communication saw the biggest contraction but that happened for four months because diesel and gasoline petrol up are included part of that. So to get the true measure of core you want to strip it out.

So, it was a pretty broad based increase for two months which ties up in what the November PMI told you that output prices are going up. So, the story that I draw from all of this is that there is actually a modest cyclical recovery underway in November and unfortunately that is meant that pricing power is perhaps increasing.

Q: Let me come to you first on the growth data, I will come to the inflation data in just a minute because I did not notice so much concern on a core from other economist but I will come to inflation in a minute. What did you make of the growth data? Are you convinced that things are at least troughing out and this 4.2 is quite clearly a one off? Let me tell u that corroborating evidence is there from industry from the corporate honchos who come on our channel that growth is not as good as they thought. They are not saying that they are in recession but Havells like they told us that they were expecting 17 percent growth and now they are adjusting to 12-14 percent. TTK Prestige, the cookers maker, the kitchen appliances makers said he was expecting 25 percent growth in the second half that is his normal rate of growth and he is now scaled it down to 12-14 percent?

Sen: There is something which has been happening for a while which we need to take note of. There are one offs events that Sajjid talked about but there is a larger trend. Rural demand which has been propping up the sector for last three years has started to taper and that it is been a trend for a while. We are at a cusp now, my sense is rural demand will continue to taper and the million dollar question is when does urban demand start picking up more than making up for the loss of the rural side.

We need to keep pretty close watch. Sajjid is right if you take of the one off factors what you are getting is not a minus 4 point something IIP's but it is probably not very different from around zero or perhaps a mild plus so that is at the heart of it. What we are seeing is features that were driving the Indian economy for the last several years are going off and we know what the reasons for that are the decline in food price inflation is again one of the indicators which seem to substantiate that.

Q: Before I come to whatever policy actions one can think off. How concerned are you about the core inflation? The numbers on face of it did not look so scary tome as Sajjid puts it but clearly he has put its math on stripping off the impact of petrol and looking at the month-on-month increases in medical, education. There is an increase in everything by about a few basis points. Would you worry that we have not yet got inflation under control?

Sen: Well, we have the fact is a lot of what you have seen in terms of the core really reflects the wage increases that have taken place in the past and so they will come out. The other point that Sajjid made which was about pricing power shifting there probably is a small element of that. Don not forget we have been through two years where corporate investments have been extremely low. So, additions to capacity have simply not happened which means that as the economy starts turning around if it does turn around then you will see pricing power shifting for may be a seven to eight month period.

Q: This long period of slowdown is also being accompanied at a time when commodity prices are crashing and export markets are not yielding any demand either. Given these two scenarios is that pricing power pushing up prices in the core CPI?

Sen: Core CPI is to break it up into two components. One is the part which is being driven by services and as far as services is concerned; a lot of it is a reflection of the delayed pass through of previous price increases through the wages. The second is what is happening in the manufacturing sector and there the real issue is that what has happened to capacity over the last two years, are we in a situation where because of rural demand there is insufficient capacity to meet the current needs.

Q: Therefore let us come to what policy can do. Do you think therefore the Governor should relent and advance? Your argument seems to be that if anything he should stay pat on interest rates?

Chinoy: That is clear from the RBI guidance which has been quite consistent over the last six months. They saw this coming a year ago; everyone knew November would be the trough of CPI inflation. If you just look at where food prices have gone over the first 10-12 days in December and take into account relatively modest increases in core inflation for December, the December CPI just because of the base normalising should be back up around 5.4-5.5 percent. So what the RBI first wants to do is understand where all of these base effects normalise, where inflation is averaging in the first quarter. My guess is it is going to be somewhere between 5.5-6 percent. I think that's the first hurdle that needs to be passed.

Undoubtedly are the risks abating by the day? Absolutely, with oil tumbling on daily basis that reduces inflation but my sense is (a) they want to wait to see where the numbers stabilise (b) they will want to see what the budget has to offer and (c) they will want to see in light of what has happened over the last two months whether this core dynamics are just data noise and they will normalise in the next month or two because input costs have collapsed and firms can normalise margins even without raising output prices or are these dynamics slightly more ominous and as there is some cyclical recovery on consumption and demand that firms who have taken large compressions will want to raise prices. There are all these uncertainties. So I firmly believe after yesterday number the RBI will wait it out probably wait post the Budget and if these core dynamics continue perhaps push any rate cut out, not prepone it

Q: Two questions - should the Governor cut rates and is he likely to lose political space, must he?

Sen: I agree with Sajjid. I do not think the Governor will cut rates as things stand although my sense is that what we have seen in terms of the reduction in the headline CPI is much larger than anybody had expected including the Governor and Sajjid is again right, once the base effect goes everything else staying on the current trend, you are probably looking at about 5 and a bit CPI number in January and February, which is well within the comfort zone but nevertheless the real question is that what happens if - two things (1) petroleum prices stabilise and start inching upwards. The second much more importantly what we do know is that the rabi sowing is significantly below par. So the danger of food inflation resurfacing towards the latter part of the first quarter of next calendar year is something that he is going to have to keep his eyes open for.

Q: Your trajectory of growth because domestically it is not picking up and globally countries like Russia is now down to half their projected purchasing power, so 0.7 percent growth for Russia. What is your sense of India's growth trajectory, IIP and GDP for the next year?

Chinoy: We have been maintaining that the first half growth in India is little bit exaggerated because all of it is driven by government spending and agriculture, which Dr. Sen pointed out that cannot sustain. Therefore, 5.3 for this year with slight downside risk after the IIP debacle and the best case scenario inching up towards 6 percent in the next fiscal year.

Q: Inflation?

Chinoy: I think it will stabilise between 5.5-6 percent in March and what will drive the trajectory next year is what happens to food prices, where is oil and will growth pick up result in high core inflation. Those are the three uncertainties for me. I am looking at 6 percent trajectory through most of 2015 close to that number throughout the year.

Q: Your view on both those numbers for the next year?

Sen: Roughly correct. On the GDP, I would take it a little higher. I would probably be talking about close to 5.5 but in my case with a slight positive bias on that.

Inflation, roughly what Sajjid said. My take is that as far as non food inflation is concerned it would be in the region of 4.5 or thereabouts with food inflation closer to 6-6.5.