Industrial growth at 21-month low

Industrial growth at 21-month low

New Delhi: India’s factory output growth dropped to a 21-month low in July, raising fresh doubts about the ability of the economy to sustain its present growth momentum.

Stocks slumped while bonds advanced as the deceleration led to speculation over whether the Reserve Bank of India (RBI) would pause its sequence of rate hikes at the review meeting due on Friday. A clearer view will emerge when inflation data for August is released on Wednesday, having stood just below the double-digit level in July.

The Index of Industrial Production (IIP) was at 3.3% in July compared with 9.9% in the year ago due to a slowdown across most sectors except electricity, which grew at 13.1%.

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The figures were disappointing, said C. Rangarajan, chairman of the Prime Minister’s economic advisory council (EAC).

“At the present moment perhaps the numbers are not encouraging..., but if the industrial production does better in the second half, then the overall growth rate may be higher," he said. “I will say that we will have to revisit the area after one or two months."

Stocks dropped the most in about three weeks on the industrial output data—the benchmark BSE Sensex fell 2.17% to 16,501.74 points. India’s 10-year bonds climbed the most in a week on speculation the central bank could halt interest-rate increases. The rupee fell to a one-year low, closing at 47.22 to the dollar, weakening 1.4%.

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EAC, in its economic outlook for the current fiscal released in July, had pegged the growth rate at 8.2%, while most private economists have revised it downward to below 8%.

The composite leading indicators (CLIs) released by the Organisation for Economic Cooperation and Development (OECD) on Monday showed the index for India further contracting to 95.7 in July from 96.5 a month ago.

“Compared to last month’s assessment, the CLIs for Canada, France, Germany, Italy, the United Kingdom, Brazil, China and India are pointing more strongly to a slowdown in economic activity," OECD said.

India was seeking to reach a middle ground between inflation and growth, said Kaushik Basu, chief economic adviser in the finance ministry. “RBI will have to balance these out and take a decision on it," he said.

RBI has stuck to its aggressive stance by raising rates 11 times since March last year to contain inflation, which is currently running above 9%, well above the central bank’s comfort level.

Finance minister Pranab Mukherjee had on 4 September, however, expressed the hope that the policy may not be continued owing to growth worries.

“I feel that the existing monetary policy of reigning in inflation may not have to be extended," Mukherjee had said in Kolkata. “If the monetary policy is extended, there will be an overall impact on the growth scenario. I am optimistic that the present monetary stance will not have to be extended."

Analysts, however, raised doubts over the reliability of the IIP data due to the sharp volatility noticed in the index recently.

The latest month data only highlights that IIP is neither a credible or reliable index, said Abheek Barua, chief economist at HDFC Bank Ltd.

“Like last month, it was understating the industrial downturn, this month it is overstating it," hesaid. In June, IIP grew at a robust 8.8%, surprising economists and policymakers.

IIP data does not give a reliable picture of ongoing economic activity, said Rajeev Malik, senior economist at CLSA Singapore, in a research note.

RBI has in the past said the volatility of IIP is “statistically bewildering".

“Unless there is more stability in the IIP data, it is unlikely to contribute to monetary policy decision-making," Barua said.

He said the volatility of the capital goods segment in IIP has “become a joke" largely due to the bunching of data. That may be why capital goods showed a contraction by 15.2%, the biggest slump in two years.

The volatility of IIP is well established, said T.C.A. Anant, chief statistician of India. “One has to see this index along with other relevant indices and draw conclusions cautiously," he said.

Consumer durables data also baffled economists. The robust growth in the sector raised a serious credibility issue as it contradicts the slowdown in credit growth and the slump in auto sales owing to the impact of the rise in interest rates, Barua said.

Consumer goods rose 6.2%—durables rising by 8.6% and non-durables by 4.1%. Intermediate goods contracted 1.1% for the first time since June 2009, while basic goods output remained healthy at 10.1%.

Car sales declined 10% in August, pulling down total passenger vehicle sales for the second month in a row as a result of rising loan rates and higher fuel costs, according to data released by the Society of Indian Automobile Manufacturers last week.

The Central Statistics Office, which releases the data, also revised IIP growth downward by a full two percentage points for April to 5.3%, from 7.3% announced earlier.

The only relevant takeaway is the contraction in intermediate goods, which could mean a sharper slowdown in factory output four-five months down the lane, Barua said.

The weak growth in mining since January this year is a result of reduced coal production due to the Supreme Court ban on the activity in some areas and the reduced production of natural gas in the KG basin area of Reliance Industries Ltd, even as crude oil output has been registering double-digit growth due to new production from the Barmer oilfield.

Fifteen out of the 22 industry groups in the manufacturing sector have shown positive growth compared with the year-ago period. Several components of the manufacturing sector such as tobacco, textiles, chemical products, machinery equipment, electrical machinery and medical instruments contracted.

Robust export growth did not tally with the IIP slump, analysts said. Merchandise exports, a subset of domestic manufacturing, grew 82% in July.

The robust performance of engineering exports should have provided some stability to IIP, Barua said.

While experts have also raised doubts about the credibility of the high export numbers, Barua said if the price effect is discounted, export growth will be around 20-35%, which looks credible.

Most economists said RBI will raise interest rates in its mid-quarter policy on 16 September.

“RBI probably does not rely significantly on the IP (industrial production) data given the recent volatility," Malik said. “RBI’s main focus will remain on checking inflation, which continues to be uncomfortably high."

Aditi Nayar, economist at Icra Ltd, agreed with Malik.

“RBI probably does not rely significantly on the IP data given the recent volatility," she said. “With inflation expected to have accelerated in August 2011, we continue to anticipate that RBI will persist with monetary tightening and hike the repo rate by 25 basis points in the upcoming policy review."

However, Prakriti Shukla and Vishal Vaibhaw of Goldman Sachs said in a report that they expect RBI to pause given the sequential slowing in inflation and the adverse global economic environment.

Graphic by Ahmed Raza Khan/Mint

Bloomberg and PTI contributed to this story.