Did capital goods production really fall 25% in July after growing 30% in June?

Did capital goods production really fall 25% in July after growing 30% in June?

The stock market doesn’t seem to be convinced the low reading for the July Index of Industrial Production (IIP) will make the Reserve Bank of India (RBI) pause. The rate-sensitive sectors all fell sharply on Monday and they should have found some support if the market believed industrial weakness would lead the central bank to change its stance.

At first glance, the IIP numbers do look terrible. The manufacturing sector, for instance, contracted 3.6% from June. And it wasn’t just the capital goods segment that contracted year-on-year (y-o-y)—intermediate goods also did so. But intermediate goods production did not shrink compared with the previous month. Capital goods production did, true to its tradition of tremendous volatility.

There’s better news on the consumption front. Consumer durables production rose by 8.6% y-o-y compared with 1.5% in June. Consumer non-durables also showed higher y-o-y growth in July than in June. Inflation doesn’t seem to be denting growth in this sector.

But one doesn’t need dodgy IIP data to get a sense of the slowdown in the economy. Car sales, the Purchasing Managers’ Index (PMI) numbers and order books of capital goods companies all show the slowdown is spreading. Also, while export growth has been strong so far, the fact is that it actually fell month-on-month in August. The chart shows that exports in August were the lowest in four months.

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Combined with the ongoing crisis in Europe, the data does make a case for a pause in rate tightening. Similar reasons have been responsible for the central banks in Indonesia, Korea, Malaysia and the Philippines all keeping their policy rates unchanged last week.

Moreover, a 25 basis points hike by the central bank may not lead to higher lending rates by commercial banks, because the incremental credit-deposit ratio for the banking sector in the last three months (till 26 August, the latest date for which data on credit and deposits is available) is 50.3%. One basis point is one-hundredth of a percentage point.

Contrast that to the incremental credit-deposit ratio of 82.7% over the year to 26 August 2011. That gives a cushion to banks not to raise lending rates. Liquidity is also much better, although the advance tax outflows will temporarily suck it out.

The problem for RBI is that the PMI numbers show that so far both input and output price pressures are strong both in manufacturing and services. It’s very likely the slowdown will, of course, lead to lower inflation in future. But it may not be prudent for the central bank to gamble on that.

Graphic by Ahmed Raza Khan/Mint

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