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1 Macroeconomic Update: CPI Inflation and IIP CPI Inflation Update (Dec-14) Highlights: Belying most market expectations, headline CPI inflation continued to remain firmly low, standing at 5% v/s consensus estimate 5.4% (our estimate: 5.7%). Core CPI inflation dipped to a new series low of 5.23%. While the headline CPI inflation for Nov-14 has not been revised, the change in internals has led the core CPI inflation for Nov-14 to stand lower at 5.46% compared to initial estimate of 5.51%. Fig 1: Trend in Combined CPI Inflation Fig 2: Trend in Rural and Urban CPI Inflation Bansi Madhavani bansi@stcipd.com Priyanka Sachdeva priyanka@stcipd.com Source: MOSPI, PD Research Belying market expectations of reversal in inflation trend, retail inflation surprised on the positive side, standing sharply lower than expectations. The drop is led by food items like vegetables, sugar and pass through impact of domestic fuel price cut. Decelerating pressure on prices of cereals, oil and fats also contributed to the 0.4% drop in headline inflation over the month. A summary of key components of CPI inflation is as under: Table 1: CPI Inflation Trends Rural Urban Combined Nov-14 Dec-14 Nov-14 Dec-14 Nov-14 Dec-14 Headline CPI 4.09% 4.71% 4.69% 5.32% 4.38% 5.00% Core CPI 5.46% 5.23% Food, beverages and tobacco 3.76% 4.89% 3.40% 5.43% 3.64% 5.06% Fuel and light 3.74% 3.80% 2.74% 2.73% 3.42% 3.41% Housing % 7.84% 7.93% 7.84% Clothing, bedding and footwear 7.59% 6.97% 5.75% 5.51% 6.90% 6.51% Miscellaneous 4.36% 4.11% 4.04% 3.71% 4.20% 3.95% Source: MOSPI, PD Research 1

2 Vegetable prices provide a reason to cheer The food, beverages and tobacco index, which forms ~50% of CPI basket, dropped over 1% in a month. Leading this fall was prices of vegetables, the index of which declined ~8% from Nov-14. Vegetables form the third largest component of food, beverage and tobacco index lead only by cereals (and products) and milk (and products). The monthly trend suggests that sharp deceleration in prices of vegetables coupled with negative monthly move in prices of heavyweight cereal and products lowered half the CPI index by 1.06% (refer: Table 2). Table 2: Monthly Momentum In Key Food Products Weight Oct-14 Nov-14 Dec-14 Cereals and products 14.59% 0.28% 0.07% -0.21% Milk and products 7.73% 0.45% 0.76% 0.25% Vegetables 5.44% -2.60% -1.62% -7.93% Oils and fats 3.90% 0.07% -0.14% -0.14% Food, beverages and tobacco 49.71% -0.20% 0.07% -1.06% Source: MOSPI, PD Research Owing to seasonality, the December month typically enjoys moderate vegetable and fruit prices. However, anecdotal evidence suggests that fall in prices of these commodities was limited, at best. Beginning last week of December, prices of certain vegetables, cereals and pulses have firmed up. Therefore, going forward, this component is likely to see some correction coupled with the wearing off of favourable season impact. However, the structural improvement in overall food inflation does inspire confidence in the sustained disinflationary trend exhibited in past few months. Reined in core inflation pressure reaffirms overall disinflationary momentum Despite registering an uptick on sequential basis, annual core CPI inflation dropped to 5.23% in Dec- 14 from a revised 5.46% in Nov-14. All components of core CPI (Housing, Clothing, bedding and footwear and Miscellaneous) noted acceleration in their price levels from previous month. In what would be routine update in collection of house rent data, the Housing index rose 1.03% from previous month. These revisions are typical observations for the months of June and December when canvassing for rent schedule takes place. We, therefore, do not see a cause of concern on that front, yet. Gaining from two rounds of domestic fuel price cut, the Transport and Communication component of services dropped 0.6% in a month. Following the slump in global crude oil prices and consequent market linked domestic fuel prices; the Transport and Communication component has contracted only 2% since July-14. On the other hand, prices of petrol and diesel have dropped 13%-14% in the same time period, suggesting likelihood of further downside in trajectory of Transport & communication component going forward. Amongst other components, the pace of price acceleration has moderated for certain services like Medical care, Personal care and effects. 2

3 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov Jan 2015 Index of Industrial Production: Nov-14 Highlights: Industrial output witnessed annual rate of expansion at 3.8% for Nov-14 after plunging unexpectedly at 4.2% in the previous reading. On sectoral basis, Electricity continued to dominate (10% vs. 13.3% previously) followed by Mining sector (3.4% vs. 3.9% previously) and Manufacturing (3% vs. 7.4% previously). On use based side, barring Consumer goods, all other components showcased impressive performance in the current reading. Fig 3: Trends in IIP and IIP Ex Capital Goods 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% IIP IIP Ex capital A summary of component-wise IIP is as under: Table 3: Annual Growth in IIP Nov-14 Apr-Nov FY15 Headline IIP 3.8% 2.2% A. Mining 3.4% 2.5% B. Manufacturing 3.0% 1.1% C. Electricity 10.0% 10.7% 1. Basic Goods 7.0% 7.5% 2. Capital Goods 6.5% 4.9% 3. Intermediate Goods 4.3% 1.8% 4. Consumer Goods -2.2% -5.7% Durable Goods -14.5% -159% Non-Durable Goods 6.0% 1.9% Source: MOSPI 3

4 Sector-wise Classification Mining sector noted an expansion of 3.4% sustaining its positive momentum seen in the previous reading at 4.9%. Since Nov-13, Mining sector has hovered in the positive territory which has imparted confidence on the durability of its performance to support growth going forward. Manufacturing sector, which drives the IIP with three-fourth contribution and is inherently volatile, recorded an annual rate of growth at 3.0% against deceleration of 7.0% in the previous reading. On monthly basis, manufacturing index was up by 6.2% after contracting by 8.6% in the preceding month s reading. Out of twenty two industry groups, sixteen industries recorded positive growth rates with wearing apparels noting highest growth rate at 19.8%. Other industries recording double digit growth rate included Motor vehicles (17.5%), fabricated metal products (12.8%), Food products and beverages (11.5%) and Luggage, handbags, harness & footwear (10.0%). The contraction in the Radio, TV and communication segment continued at 60% in the current reading following drop of 70.2% and 43.8% in the preceding readings. Other industry groups acting as a drag on the manufacturing output included Office, accounting & computer machinery (-26.3%) and Tobacco products (-17.4%). Electricity sector continued with its stellar performance and grew at 10% for Nov-14 on annual basis compared to 13.3% in the previous reading. Of its components, Thermal electricity generation grew by 13.56% over same period year ago. However, Hydro and Nuclear electricity generation noted degrowth of 10.17% (-7% in Oct-14) and 4.11% (-10% in Oct-14) respectively. Use-based Classification Basic goods registered annual growth rate at 7% in the latest IIP print compared to 5.9% in the previous reading. This sector has been growing at impressive pace with growth averaging 7.6% since Apr-14. Both Mining and Electricity sector which constitutes majority have been growing at sustained pace since Apr-14. Intermediate goods grew by 4.3% over same period year ago taking cumulative growth rate to 1.8% for FY15. Capital goods sector came in positive zone recording annual rate of growth at 6.5% after declining in the previous reading by 3.2%. Amongst its components, Commercial sector which forms the majority noted growth rate of 20% as per the latest reading. Other segments of capital sector exhibiting high growth rates included Three Wheelers (42.5%) and Aluminium conductor (115%). Consumer goods stayed in negative zone for yet another month belying hopes of any rebound in this sector. However pace of decline is lower in the current reading at 2.2% against sharp fall of 18% in the preceding month. While Consumer Durables contracted by 14.5%, Non-Durables expanded by 6% over same period a year ago. Amongst its components, positive momentum was provided by Air conditioner (53.8%), Scooter mopeds (30.7%), Sugar (49.5%), Leather garments (40.3%) and Cotton cloth (23.8%). On the other side, sectors dampening the growth of this sector included Telephone instruments (67.3%), Antibiotics & its preparations (20.7%) and Cigarettes (23.3%). 4

5 Concluding Remarks The domestic macroeconomics came under the scanner once again, with whiff of global turmoil in the background. Given the several uncertainties on global front ranging from sudden risks to emerging economies on account of Russia, brewing tensions in Euro zone on account of Greece elections and continuing concern over pace and timeline of rate hike by US Federal Reserve have only highlighted the need to ensure domestic stability. This necessitates moderate level of inflation and boost to overall growth dynamics. IIP reading at 3.8% for the month of Nov-14 triggered renewed optimism with regards the growth prospects of economy. While the positive momentum was seen across the board, it might be premature to assume that the growth has bottomed out. With Government expediting its initiatives to address the bottlenecks clogging this sector, hopes are pinned on this sector to mushroom on sustainable basis. While investment cycle seems to have picked up with new project announcements rising to 12.3% in Q4FY14 against 8.8% in Q3 (CMIE data), consumption is yet to confirm any major turnaround. Despite IIP posting higher growth rate than anticipated, it might not indicate the reversal of economic cycle given the volatile nature of IIP data. In this regard, there is a need to adopt wait and watch strategy to comprehend the sustainability of uptick seen in the latest print. With the distinct fall in CPI inflation, even stripping off of base effect, it appears that inflation menace has been contained, if not completely eliminated. Since the Dr Patel committee proposed the Inflation Targeting Framework and laid down headline CPI inflation targets in Jan-14, the retail inflation has dropped a massive 487 bps from 9.87% in Dec-13 to 5% in Dec-14 coupled with a core CPI inflation drop of 286 bps. With the first target of 8% by Jan-15 expected to be undershot by over 200 bps, it is indeed a laudatory job by RBI and government to join hands in this achievement. At this juncture, the CPI inflation is expected to stay at an average 5.7%-5.8% for the rest of FY15. The clamors for policy rate cut have never been higher. The positive surprise on inflation front and foreseeable sustainability of moderate inflation trend has only validated these calls with strong data. Against this backdrop, the Monetary Policy Review of 3-Feb-15 will pose RBI with dilemma of concerns over fiscal health of the economy on one side and need for accommodative policy stance acknowledging the fall in inflation on the other side. The debate has shifted from direction that policy rates should embark on to the timing of first rate cut. Against this backdrop, we believe that RBI will ease interest rates by 50 bps in rest of FY15. Post the Dec-14 policy, the G-Sec market has rallied with increased expectation of start of an easing interest rate cycle sooner rather than later. The recent data only corroborates these market sentiments and indeed is expected to add momentum. Ahead of the Feb-14 Monetary Policy Review, we expect the benchmark 10 Yr G-Sec to stay in the range of 7.60%- 7.80%. 5

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