Mumbai: The amber lights have started flashing. At 2.7%, the latest numbers show factory output expanded in November at its slowest pace since the Indian economy recovered from the brutal downturn that came in the wake of the Western financial crisis.
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Economists were anticipating anaemic growth in industrial production in November, but the first estimate released by the government on Wednesday was far lower than consensus estimates of around 6.6%. The Index of Industrial Production (IIP) has bounced around a lot this fiscal, with a month of weak growth followed by a month of strong growth. Deutsche Bank said in a research note that the standard deviation, a volatility measure, of IIP in 2010 is 50% more than what it was in 2005-09. This curious volatility suggests that industrial growth should ricochet off its November lows. The economy is nowhere near the situation during the crisis months, when IIP growth was below 2% for seven out of eight months from October 2008.
But the signs of an industrial slowdown are clear even when the recent volatility is squeezed out of the IIP data. Year-on-year growth in the three-month moving average of IIP unmistakably shows a downward drift (see chart). The smoothened data shows that industrial growth peaked in February 2010 and has been falling back to long-term average levels since then.
A government already battling resurgent inflation will now also have to worry about whether industrial activity is set to deteriorate in 2011, and thus hurt overall economic growth. The Reserve Bank of India (RBI) will have to think hard whether it should raise interest rates aggressively to quell inflation or hold its fire in an attempt to support industrial growth.
The central bank is due to review its monetary policy on 25 January and the government will present its new budget for fiscal 2012 at the end of February. The toxic mix of high inflation and weakening industrial activity is likely to complicate policy choices.
India will still end this fiscal with an industrial growth of around 8.5%, which is higher than the 8.1% averaged over the past seven years. However, maintaining industrial growth around this long-term average could be a significant challenge in FY12, as persistent inflation eats into household budgets, and higher interest rates curb animal spirits of entrepreneurs and companies. The big question is what Indian policymakers give priority to: inflation control or industrial revival?
The current climate is good neither for consumers nor companies. It is worth noting that senior government officials have broadly hinted that the November IIP data leaves them worried. Finance minister Pranab Mukherjee on Wednesday spoke about the need to take “corrective measures” to revive industrial growth in the last four months of the current fiscal. These worries are justified. There are already several other indicators of economic activity to show that the industrial engine could be losing momentum.
Weakening growth in railway freight and sales of commercial vehicles is a leading indicator that the demand for moving goods around the country is abating. Cement dispatches plummeted in November, which is perhaps a sign that demand from the construction and infrastructure sectors is under pressure. Non-oil imports (three-fourths of which are industrial inputs), too, have come off their robust highs in July and August. Data on electricity production has not provided much to write home about.
There are still strands of data that provide some hope for optimism. Non-food credit given out by banks continues to increase at a fast pace; car sales grew by a handsome 29% in December; the HSBC Markit Purchasing Managers’ Index was above 50, an indication of industrial growth, for the 21st month in a row in December; and businessmen polled by RBI for its industrial outlook survey say that they are still optimistic about a good third quarter.
This jumble of data naturally gives mixed signals. But the November IIP shocker tilts the balance. While many economists have pointed out that the low IIP growth in November was because of a bunching of festival-related holidays in that month, there are reasons to worry about growing problems in the Indian manufacturing sector that could exacerbate as the country’s central bank continues to increase interest rates to battle inflation as it continues to be above the comfort zone.
“Recent interest rate increases from the central bank have curbed household demand for consumer goods and business demand for capital goods, further dampening industrial production levels,” wrote Moody’s Analytics senior economist Matt Robinson in a Wednesday note.
In fact, there could be a link between the recent spike in inflation worries and consumer demand. The sustained rise in consumer prices in general and food prices in particular seem to be pinching family budgets. While policymakers have tried hard to assuage citizen fears about rampaging inflation, ordinary Indians are clearly not impressed.
Inflation expectations have been on the upswing. The latest survey of households conducted by RBI shows the inconvenient truth that fast-rising consumer prices are playing on the minds of customers. They expect inflation to be in double digits even one year down the line, as against the official policy view that inflation will moderate by the end of the current fiscal. The actual and anticipated damage to family budgets because of high inflation could hit consumer demand for manufactured goods.
The steep 6% annualized decline in the output of consumer non-durables—largely stuff bought regularly for personal and household consumption—is perhaps one indication that consumers are going into a shell. Production of capital goods—an indicator of corporate investment—has been unbelievably volatile this year. The 12.6% growth in capital goods output in November is good news, especially since investment activity has still not fully recovered.
The coming months will see important policy decisions from the government and the central bank. India is currently chugging along with a very loose fiscal policy and a moderately loose monetary policy. There will now be a temptation to continue along this path, using the argument that the economy still needs policy support and high inflation can be tolerated for a few more months. India ignored the inflation threat for too long by being behind the curve when it came to tightening policies. Inflation will likely continue to be public enemy No. 1 in 2011.