New Delhi/Mumbai: India’s factory output in December fell more sharply than expected, and inflation slowed to a one-year low, setting the stage for the country’s central bank to reduce interest rates to revive a slowing economy.
On 8 February, Reserve Bank of India (RBI) governor D. Subbarao had said that there was room to adjust interest rates further to spur the economy as inflation eases.
Also See Inflation Declines (Graphic)
On Thursday, the good news on the inflation front, brought about largely by a cut in fuel prices, was more than offset by the poor factory output numbers and the Bombay Stock Exchange’s benchmark Sensex index reacted by falling 1.6%.
In December, the Index of Industrial Production (IIP), a measure of factory output, fell to a 15-year low. It contracted by 2% compared with a year ago, significantly worse than the 0.4% predicted by a Bloomberg poll. The numbers come in the wake of a 1.7% gain in November and a 0.3% contraction in October, the Central Statistical Organisation (CSO) said.
Inflation, too, as measured by the Wholesale Price Index, beat expectations. Wholesale prices climbed 4.39% in the last week of January from a year ago, after gaining 5.07% the previous week, the commerce ministry said. Economists expected an increase of 4.41%.
India’s economy is likely to expand 7.1% in the year to 31 March, the government said earlier this week. This will be the slowest pace of expansion in six years and comes in the wake of a minimum growth of 9% in the previous three years.
Both the factory output and inflation numbers, however, sparked talk of an imminent rate cut by RBI. Bonds rallied even as the market continued to feel the impact of the government’s announcement, on Tuesday, that it would borrow an additional Rs46,000 crore in the year to 31 March.
“The latest IIP data strengthen our conviction of an imminent cut of 50–100 basis points cut in policy rates and/or cash reserve ratio by the RBI. Most likely, the action could come soon after the vote-on-account (interim budget) on 16 February,” said Rajeev Malik, head of India and Asean economics at Macquarie Capital Securities, Singapore.
One basis point is one-hundredth of a percentage point.
RBI kept interest rates unchanged in its policy review on 27 January after reducing them to an unprecedented low on 2 January. Since October, it has cut a rate indicative of the short-term lending rate, known as the repurchase or repo rate (this is the rate at which RBI lends to banks) by 350 basis points to 5.5% and the cash reserve ratio, which defines the amount of money banks need to keep with RBI by 400 basis points to 5%.
Economists and analysts also expect the government to unveil a stimulus package when it presents the interim budget on 16 February.
Pradeep Madhav, managing director of STCI Primary Dealer Ltd, a firm that trades in government bonds, expects a fiscal package and a rate cut. “The cut may not be as aggressive as we have seen in the past, but I would expect that it should about 50 basis points.”
Waning demand is forcing companies to scale back output and fire workers. Job losses may prompt the government, which faces elections before May, to boost spending in next week’s interim budget.
The situation is grim and we need some solid support from the government to revive demand significantly, said Dilip Chenoy, director general of the Society of Indian Automobile Manufacturers. He added that the industry body would like RBI to cut rates further to stimulate demand for automobiles.
The global recession is hurting manufacturing firms across Asia. South Korea’s production plunged by a record 18.6% in December. China’s industrial output grew 5.7% in the same month, close to the weakest pace in almost a decade.
India’s exports fell 22% in January from a year earlier, the fourth straight monthly decline, according to trade secretary Gopal K. Pillai. The fall in exports could continue for several more months, Pillai had said in January. Falling exports could cause about 10 million job losses by March, according to estimates from lobby group Federation of Indian Export Organisations.
There seems little prospect of a trend reversal in the next few months as the global downturn intensifies, said Robert Prior-Wandesforde, an economist at HSBC Group Plc. in Singapore.
CSO says the industrial sector will grow at 4.8% in 2008-09, but analysts say this is an optimistic estimate. Axis Bank economist Saugata Bhattacharya expects the industry to grow at 3.5%.
The finer details
Within the broader number, growth in output of intermediate goods continued to contract for the fifth consecutive month, while that of capital and basic goods were up 4.2% and 1.7%, respectively.
A sharp contraction of 12.8% in consumer durables output in December has, however, surprised analysts. “Given the fiscal stimulus, latent rural demand and pay commission recommendations, we had expected growth in consumer goods to moderate and not slump,” Citibank’s Rohini Malkani and Anushka Shah said in a report.
“We continue to expect activity to slow considerably in the second half of FY09, after growing by 7.8% in the first half. Our estimate for GDP growth remains unchanged at 6.7% y-o-y for FY09 and 5.8% for FY10. We expect RBI to ease both the repo and reverse repo rates by 50 basis points each by end-March,” Pranjul Bhandari and Tushar Poddar of Goldman Sachs said in a research report released on Thursday.
However, Bhattacharya said RBI could delay a rate cut and instead take more direct measures such as open market operations as “the rate cuts do not seem to be helping (in bringing down interest rates).”
Kartik Goyal is with Bloomberg.
Graphics by Ahmed Raza Khan / Mint