High inflation is here; but growth is still the missing link

CPI inflation touched a 40-month high of 5.54% for the month of November.

December 13, 2019 9:51 IST | India Infoline News Service
The last three months have been testing times for the Indian economy. Inflation has shot up and growth has dipped into negative territory. The latest retail inflation number for November and the IIP for October only added to the macro red flags that are already being raised about the Indian economy. Both the IIP and CPI Inflation were announced on December 12th and both disappointed. CPI inflation touched a 40-month high of 5.54% for the month of November. At the same time, the index of industrial production (IIP) for October 2019 remained in negative territory for the third month in succession. Let us look at inflation first.
Runaway food inflation pushes up CPI inflation by 92 bps

Data Source: MOSPI

The trend line of the chart clearly shows the sharpening in the last few months. Inflation at 5.54% means that the real interest rate in India has fallen from 4% to negative territory in a little over a year. For November 2019, the big driver for CPI inflation was food prices. Food inflation for November came in at 8.66% largely driven by vegetable inflation at an unprecedented 36%. Clearly, onions appear to have taken its toll on the food basket and that could taper with recent imports from Turkey and Afghanistan likely to improve the supply situation in India. Core inflation has remained subdued even as fuel inflation has gone into negative. But this could change rapidly if oil prices continue to remain at elevated levels in the global market. Rural inflation has now picked up close to urban inflation levels. Food inflation remains the key irritant for CPI inflation going ahead.
Industrial production stays negative for third month in succession

Data Source: MOSPI
IIP at (-3.8%) for October is not just disappointing, but also marks the third successive month of negative IIP growth. Officially, this is an industrial slowdown, although the government may not have called it so. The gravity of the problem is evident from the fact that 18 out of the 23 sectors considered in this analysis have shown negative growth. During the month of October, Mining was down (-8%), manufacturing was down (-2.1%) and Electricity generation was down (-12.2%). Manufacturing with the highest weightage had the most gravitational impact on the IIP. Some of the key product groups like computers, electronics, motor vehicles, trailers have shown negative growth to the tune of nearly (-30%). In terms of user based classification, capital goods showed a negative growth of (-21.9%), clearly indicating the pressure on the capital investment cycle. If you look at the Apr-Oct period of 2019, the IIP growth was just 0.5% on a YOY basis; not a good signal for the full year GDP growth numbers.
What are the likely implications of high inflation and weak growth?
  • Had this been September 2019, we could have said with confidence that the weak IIP growth will spur the RBI to cut rates further. But the December monetary policy has shifted the onus of RBI policy from growth revival to inflation control. Here are four likely implications of the inflation and IIP numbers.
  • The RBI has already suggested to the government to cut rates on small savings and it may be time to bite the bullet. Cutting rates on small savings will allow banks the leeway to cut rates on deposits and then pass on the same to borrowers. Right now, transmission of rate cuts is stuck because of the small savings conundrum.
  • With 3 successive months of negative growth, it is officially a manufacturing slowdown. The RBI has downsized the full year GDP growth to 5%, but if Q3 also disappoints, then even that may appear to be a tall order.
  • It is time for India to get a little liberal on the fiscal policy front. The whole idea of fiscal pump priming is to be counter-cyclical. Government needs to boost fiscal spending even if the fiscal deficit is likely to overshoot for the next couple of years. There really is not much of a choice!
Monetary enthusiasts will have to reconcile to another status quo on rates in Feb-20. With repo rates at 5.15% and inflation at 5.54%, real rates are already negative. That leaves little room for monetary manoeuvre. In February, RBI may have to focus more on protecting the real rates.

CPI and IIP have left the government with a lot of posers. The next few days could be interesting!

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