Factory output fall may force RBI hand

Factory output fall may force RBI hand

New Delhi: India’s factory output contracted in October for the first time since June 2009, stoking fears of a slowdown, but by the end of the day the attention had shifted to the Reserve Bank of India (RBI), with analysts weighing the possibility that monetary policy will be eased.

Production at factories, mines and utilities fell 5.1% in the month from a year earlier, making things worse for a beleaguered government that is trying to rise above a spate of corruption scandals and its continuing inability to rein in inflation to revive the country’s economic fortunes. The number was well below expectations: a Bloomberg News survey of 24 economists came up with a median estimate of -0.7%. It is the worst fall since March 2009. Cumulatively, in the seven months between 1 April and 31 October, factory output grew by 3.5% compared with 8.7% during the same period last year.

In a day that India would rather forget, the rupee, already reeling from a large current account deficit, closed at a new low of 52.789 to the dollar after foreign investors sold Indian stocks following the announcement of the factory output data. India’s currency has fallen around 15% this year, another headache for the central bank because its weakness fuels imported inflation.

The factory output data could pressurize RBI to pause its liquidity tightening drive on Friday; RBI has raised interest rates 13 times since March 2010 by a total of 3.75 percentage points (the fastest round of increases since the central bank was established in 1935), but this effort has hit growth rather than countering inflation, which has been above 9% all year.

It increases the odds of a major shift in RBI’s language on Friday, said Dariusz Kowalczyk, a senior economist with Credit Agricole CIB in Hong Kong. He expects RBI to keep the policy rate intact at 8.5%, but sees rate cuts in 2012.

Samiran Chakraborty, head of India research at Standard Chartered Bank, said while the number could make RBI “change its bias towards growth", there is “no magic wand with RBI to kickstart growth".

Ahmed Raza Khan/Mint

RBI also has to factor in Europe’s debt crisis that is sapping global economic growth. Central banks elsewhere, including China and Brazil (which, along with Russia and India are part of the BRIC grouping), have eased monetary policy after their economies felt the impact of the euro zone’s debt crisis, but RBI’s task is complicated by high inflation.

Coping with slow growth

The Organisation for Economic Co-operation and Development said in a release on Monday that its composite leading indicator points strongly to economic activity falling below the long-term trend in countries such as India and Brazil.

That would seem to be the popular view.

In its global economic review on Monday, Standard Chartered cut its growth projection for India in 2011-12 to 7% from 7.4% projected earlier. Barua said he was revising his growth forecast to 7% from 7.3%. Last Friday, the government said in its mid-year economic review that the economy could expand 7.25-7.75% in 2011-12; most economists disagree.

Reacting to the poor factory output number, the commerce ministry said in a statement that commerce minister Anand Sharma will discuss the sharp decline in output with representatives of government and industry on 19 December.

The government could help, said Chakraborty. While there is little room (given the government’s finances; fiscal deficit is expected to reach 5.5% of GDP in 2011-12, a full percentage point over target) of a fiscal stimulus, faster decision-making in terms of removing bottlenecks which the industry is facing will augur well for the economy, he said.

Just last week, Prime Minister Manmohan Singh made an embarrassing retreat from opening up the retail sector to foreign companies such as Wal-Mart Stores Inc.

Manufacturing problem

Manufacturing output, which contributes around 76% to factory output, fell 6% in October from a year earlier, reflecting weak demand at home and overseas.

Finance minister Pranab Mukherjee said on Friday that the economy may face a greater problem if the manufacturing sector does not pick up.

“We need 10-12% growth in the sector. For that, we have to create confidence by allowing institutions to function and create a conducive atmosphere where investment comes," he said in the Lok Sabha.

Monday’s data also showed production of capital goods contracting 25.5%; capital goods output is a measure of investment. “The real concern is that capital investments are not coming in today. This is going to have a further negative impact on" factory output numbers, said Ramesh Chandak, chief executive of KEC International and president of the Indian Electricals and Electronics Manufacturing Association. Economists are also worried about output of consumer durables contracting 0.3% in October.

“We were already witnessing stagnation in investment. Now it is percolating into consumer goods, which paints a rather grim picture," Chakraborty said.

The numbers game

Economists said that while the factory output data is suspect, the trend shows the slowdown is for real. “IIP numbers have been very volatile of late, so the sharp decline in IIP should be taken with a pinch of salt. But that should not make us complacent. There is clearly an industrial slowdown, though the extent of the slowdown can be debated," said Chakraborty.

The new series of factory output data, with 2004-05 as the base year, has come under fire from several quarters. RBI governor D. Subbarao has previously said that the volatility in the data is “statistically bewildering". Mint reported on Wednesday that the department of industrial policy and promotion, an arm of the commerce ministry, has decided to terminate a contract with the Centre for Monitoring Indian Economy for collecting the data used in the calculation.

Deutsche Bank said in a report released on Monday that the data could be exaggerating the extent of the weakness, as there were festival and holiday-related disruptions in production during the month. “Consequently, we expect the growth to show an improvement in the coming months, though continuing to be below trend for a few more quarters," it added.

Barua said though there was a base effect (a high number last October), and though the festive season impacted industrial production in October, the data clearly indicates growth is faltering. He added that he expects factory output to grow between 1% and 3% in the next few months. “For the full financial year, we are projecting growth of 3.5-4%," he said.

Reuters and Bloomberg contributed to this story.