According to HSBC's India PMI, growth in the manufacturing sector eased on the back of weaker growth in output and a slowdown in order flows from domestic clients. By goods, consumer goods firmed, but the production of investment goods remains subdued according to panellists. Looking ahead, the recovery is likely to prove protracted. Meanwhile, inflation eased in March, with the PMI index for input and output prices falling. The RBI will likely keep policy rates unchanged today, but this may not be the end of the tightening cycle given the lingering upside risks to inflation.
- HSBC's India manufacturing PMI declined in March (51.3 vs. 52.5 in February), but remained above the waterline, indicating positive growth. Output (52.2 vs. 54.0 in February) and new orders (52.7 vs. 54.9 in February) slowed, but new export orders (56.8 vs. 54.1 in February) accelerated. This indicates that the slowdown was domestically led.- In line with the slowdown in order flows, quantity of purchases (51.7 vs. 52.8 in February) was scaled back. Meanwhile, stocks of finished goods (51.4 vs. 51.4 in February) grew at a steady pace while stocks of purchases (49.9 vs. 49.4 in February) were broadly flat after falling the previous month. - Backlogs of work (53.0 vs. 52.9 in February) continued to increase, but supplier delivery timeliness (50.5 vs. 49.4 in February) improved. Meanwhile, employment was unchanged (50.2 vs. 50.2 in February). - On the inflation front, input (57.2 vs. 61.0 in February) and output price (51.0 vs. 51.4 in February) inflation eased, notwithstanding lingering cost pressures due to higher raw material costs.
The momentum in manufacturing eased led by a slowdown in domestic demand. Raw material shortages, increased competition and elections were cited by panellists as reasons for weak output growth and order flows. Fiscal tightening may also have played a role. Meanwhile, external demand firmed, particularly for consumer goods. Investment, however, remains the weakest link, with panellist pointing to a still soggy investment climate.
In the near term, there are several factors constraining growth. Fiscal tightening to meet consolidation targets in FY2014-15 is one. Moreover, the RBI will have to keep its inflation guards up given lingering inflation pressures. In addition, a relatively high level of corporate leverage and deteriorating bank asset quality will hold back growth. Finally, structural constraints are still in place and it will take time to tackle these.
Beyond the near term, an investment-led recovery is a precondition for a sustained recovery in growth. The turn in the investment cycle has to be driven by stepped up implementation of structural reforms and execution of the investment projects that have now been cleared on paper. This will help lift growth expectations and, thereby, encourage more investment.
Bringing inflation under control and delivering on fiscal consolidation is also critical. It will help stabilize macroeconomic conditions and, in the latter case, crowd in the private sector. This, in turn, will reduce uncertainty, which will also help create a more conducive investment climate.
While we believe a recovery is in the cards next fiscal year, it is likely to prove protracted. We currently forecast GDP growth to come in at 5.3% next fiscal year, but that assumes that the necessary macroeconomic adjustment and structural policy measures are introduced without undue delays.
Whether that will happen or not depends importantly on the upcoming elections and the strength of the mandate of the elected government. However, even if the elected government gets a workable mandate, economic reforms and infrastructure projects cannot get switched on immediately.
It will still take time to get these things through the political machinery and bureaucratic spider web. It is, consequently, important to not overestimate the short term impact of the election on the real economy. At the same time, one shouldn't underestimate the medium term implications as the mandate is important for the traction of the much needed reforms.
Inflation pressures have eased, but inflation remains elevated. Input costs continue to rise at a sharp pace, but the weak demand is constraining the ability of some firms to pass on cost increases to final prices. According to panellists, capital goods companies find it particularly difficult to pass on higher costs.
Despite the recent softening of inflation, the RBI is likely to keep policy rates unchanged today given the persistence of core inflation. However, we may not be at the end of the tightening cycle. Inflation expectations are elevated and we are still a far cry from the 2-6% inflation target range proposed by Deputy Governor Patel's panel.
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