Higher IIP numbers signal good news for the economy but inflation battle isn’t over yet


The Consumer Price Index (CPI) and Index of Industrial Production (IIP) numbers will be closely watched for the rest of the year as they will be crucial for forming opinions on overall industrial growth and future trajectory of interest rates. The Wholesale Price Index (WPI), on the other hand, will provide a true picture on producer prices though it will not be pertinent for policy formulation.

CPI inflation has been projected in the downward direction by the Reserve Bank of India (RBI) for the second half of the year in the range of 3.8-4.5 percent which really means that a call on changes in repo rate will be contingent on how this number moves. WPI is moving in the 5 percent plus region and for September was 5.1 percent. It will continue to remain in this region as the fuel complex will exert upward pressure.

IIP growth will be important because we have had low industrial growth numbers for quite some time now and the question normally asked is as to whether or not the economy will get into the takeoff stage.

CPI inflation has come in at 3.7 percent for September which is lower than what was expected mainly because the prices of petrol and diesel had risen sharply this month as the global crude price reined at a higher level. Also, the fall in rupee was sharp in this month. Looking closely at the composition of the CPI, the picture we get is not as comfortable as the headline number of 3.7 percent.

The CPI inflation number has trended downwards in the last couple of years mainly due to lower food prices. This category has a weight of around 46 percent in the index and has been moving just around 1 percent and  often slipping into negative territory.

Two consistent trends have been negative movement for pulses and sugar which is a fallout of high production in successive years which has depressed prices. Add to this the fact that inflation for vegetables is also negative and food inflation has been 1.1 percent for September. But this is where the good story ends.

Don’t Miss: WPI inflation rises to two-month high of 5.13% in September on hardening of food prices, increase in fuel cost

The other components of non-food inflation have tended to always be above four percent. Clothing and footwear has registered an increase of 4.6 percent and has been affected by the Goods and Services Tax (GST) regime which has tended to increase prices.

Housing is up by 7.1 percent, which a statistical phenomenon is given that it is reckoned on the HRA received by government employees which has increased post the recommendations of the Pay Commission.

Fuel and light had an increase of 8.5 percent while the miscellaneous category had inflation of 5.7 percent. Therefore, it can be seen that lower food inflation has resulted in lower headline inflation.

More importantly, these components are unlikely to move downwards and could go up further with time as corporates increase their selling power. Therefore, CPI inflation at 3.7 percent gives less comfort than what it would have been in case this rate was well-dispersed across segments.

An interesting observation here is also that for the 22 states on which CPI inflation rates have been shared, 14 had rates that were higher than the average. Therefore, state-based inflation has been quite varied ranging from 1.4 percent in Rajasthan to 6.3 percent in West Bengal. This can be attributed more to the higher food inflation in these states as they vary considerably based on local conditions.

WPI inflation is once again higher than CPI inflation and will continue to be so as fuel has a higher weight in this index and will move upwards depending on the crude oil price. Also as manufacturers regain pricing power, there will be a tendency for inflation of manufactured goods to also remain elevated in the 4 percent plus region.

The IIP story is probably straighter. The growth rate of 4.3 percent for August though lower than that in June and July was on expected lines. Last year on account of GST, there was considerable destocking and restocking of goods which has provided sharp movements in the IIP growth rate. Therefore, we can expect volatile movements in growth rates for this year as the base effect would play an important role here. On a cumulative basis, there was a growth of 5.2 percent which is quite satisfactory and if maintained could lead to an average of 5-6% for the year.

The good part of the IIP growth is that it has been well spread across all the segments though the rates have been moderate for some – capital goods, infra goods and both consumer durables and nondurables have clocked over 5 percent while primary and intermediate have scored around 2.5 percent each. The important part is whether this growth can be sustained. There are reasons to believe that demand will remain buoyant in the months of September-December.

First, rural demand should be on course given that the kharif harvest should be good in several products. Cotton, pulses and some coarse cereals are projected to be lower, but otherwise combined with the MSP announced for these crops, there should be some sustained spending.

Second, the festival season is on and the preliminary reports of the e-tail sales which are on presently suggest that there is vibrancy in demand. Third, there has been some pent-up demand which has not materialised in the last 2-3 years which should be seen now.

Fourth, to the extent that export markets are better, there could be some incremental push coming for some products. All this put together should forge strong backward linkages with capital goods, intermediates and primary goods. Add to this the fact that the RBI has mentioned that there is sustained increase in capacity utilisation rates in manufacturing, there should be some increase in investment that will get reflected well in capital goods through.

The government has also been so far on track with its capex which augurs well for the future. Therefore, there is definitely some positive to be seen in the IIP growth numbers in the future if the story plays out as per the script outlined. Given that there would be no major reform which can be a disruption like the GST or demonetisation, a gradual upward movement can be envisaged here.

In the case of CPI inflation, ‘a wait and watch’ approach is suggested as there are signals that the number can increase but not really come down. WPI will continue to remain ahead of CPI inflation. Maybe the oil economics which becomes clearer next month will give final direction for the rupee as well as future inflation.