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November 2014

CRISIL Economy First Cut


Inflation falls but RBI to remain on hold
Overview: Retail inflation fell to 5.5% in October below the RBIs target of 6% for January 2016 largely led by falling
vegetable prices. With inflation falling and industrial growth still not picking up, the call for reduction in the repo rate to
boost growth and investment is getting louder.
In Q2 as a whole, industrial GDP growth (excluding construction) is estimated at 1.2% compared to 4% in Q1. Despite
this, we expect the RBI to maintain repo rate at 8% for the rest of this fiscal. We believe that the RBI would wait till there
are clear indications that the fall in inflation will be sustained, before beginning to lower repo rate. In fact, excluding
vegetable prices, retail inflation in October fell to 6.1%.
We also believe that a rate cut will yield little return in terms of higher investment as the root cause for slowing investments
have been policy uncertainties and slowing demand in the economy (see CRISIL Research Report Will a rate cut spur
investments?).

Another positive print for inflation


CPI inflation fell to 5.5% in October from 6.5% last month driven by a fall in food inflation (fell to 5.6% from 7.7% in
September). The seasonally adjusted month on month momentum in food inflation was muted at 0.02% highlighting that
the recent decline was in large part due to a strong base effect. In the food basket, the most significant decline came
from vegetable inflation which dropped to -1.4% in the month from 8.6% in September. If we assume that last year
vegetable prices had risen by half the actual amount (i.e. 20%) resulting in a lower base, then headline inflation this
month would have been close to 7%, keeping everything else constant.
Core inflation remained broadly unchanged falling slightly from 6.0% last month to 5.9% in October. This is the lowest
core inflation recorded since the beginning of the new CPI series. Inflation in household requisites fell for the third
consecutive month to 3.2% while remaining low in transport and communication (2.7%).
A significant decline in crude oil prices globally has contributed to the downward price pressures in transport and
communication and fuel inflation. Crude oil prices for the Indian basket ended the October month at $83.8/bbl as
compared to $95.3/bbl at the beginning of the month. We expect this to continue going forward and crude oil prices
globally to average at $100/bbl. in this fiscal as compared to $105.5/bbl. in 2013-14.

But no room for RBI to shift sides for now


Food inflation is likely to moderate further next month as a favourable base effect from last year kicks in - food inflation
had surged to an average 13% during September-December 2013 due to a supply-side shock to vegetable prices. This
will keep headline inflation much below 8%. Inflation is likely to remain muted in the third quarter due to a strong base

CRISIL Economy First Cut

effect, lower crude oil prices and decreased shocks to food inflation. However, we believe that it will pick up slightly in
the last quarter of this fiscal as the impact from the base effect wears off (Figure 2), inflation expectations rise, impact of
monetary policies rate hikes from last year recede and a pickup in domestic activity restricts a fall in core inflation. We
expect inflation to average at 7.2% in fiscal 2015.
In the medium term, maintaining the 6% retail inflation still remains a challenge, especially when growth begins to pick
up, as supply side inefficiencies need to be addressed in the farm to fork system. Given the inflation dynamics, we expect
RBI to remain on hold for this fiscal despite the recent moderation in Inflation. In addition, in a recent CRISIL Research
report Will a rate cut spur investment? shows that factors behind the recent slowdown in economic growth and
investment in India have little to do with high interest rates. While, the primary reason for the slowdown has been a sharp
fall in the expected return on investments due to policy uncertainty and slowing domestic demand. Thus a rate cut will
yield little return while at the same time increasing the risks of reversing the recent gain in inflation.
Figure 1: Inflation moderates as food inflation edges
down

Headline inflation

17

Figure 2: Base effect to wear off in Q4

Food inflation

1.5

Core inflation

15

1.0

13

0.5

11

0.0

%yr

Base effect (RHS)


Headline inflation

ppt

10
8
6
4

-0.5

Source: Central Statistical Office, CRISIL Research

Mar-15

Jan-15

Feb-15

Dec-14

Nov-14

Oct-14

Sep-14

Jul-14

Aug-14

Jun-14

0
May-14

-1.5
Apr-14

Oct-14

Aug-14

Jun-14

Apr-14

Feb-14

Dec-13

Oct-13

Aug-13

Jun-13

Apr-13

Feb-13

Dec-12

Oct-12

-1.0
Mar-14

RBI target of 6%

Jan-14

Feb-14

Source: Central Statistical Office, CRISIL Research

Table 1: Persistence of CPI inflation, year-on-year

CPI (%y-o-y)
Headline CPI
Food CPI
Cereals & Products
Vegetable & fruits
Milk & Milk products
Fuel & Light
Core CPI
Housing
Clothing, bedding & footwear
Transport and communication

Weight Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14
100.0
8.8
8.0
8.3
8.6
8.3
7.5
8.0
7.7
6.5
5.5
42.7
10.0
8.6
9.2
9.8
9.6
8.0
9.4
9.4
7.6
5.6
14.6
11.3
9.8
9.5
9.5
8.8
7.6
7.5
7.3
6.4
6.0
7.3
20.1
14.8
17.1
18.8
17.3
12.1
18.2
17.1
11.6
2.6
7.7
9.8
10.2
11.0
11.3
11.3
11.1
11.3
11.7
11.0
10.8
9.5
6.5
6.1
6.3
5.9
5.0
4.7
4.5
4.2
3.5
3.3
47.8
8.1
7.9
7.9
8.0
7.8
7.5
7.3
6.9
6.0
5.9
9.8
10.2
9.9
9.9
9.7
9.2
9.1
8.9
8.5
8.1
8.0
4.7
9.1
9.1
9.0
8.7
8.8
8.6
8.7
8.4
7.6
7.4
7.6
7.3
6.4
5.9
6.2
7.0
6.3
5.9
4.7
2.5
2.7

Below 4%

4-6%

Source: CSO, CRISIL Research

2 2

6-8%

8-10% >10%

IIP: A dismal Q2 for industry, but is Q3 also shaky?

IIP growth for September came in at 2.5%, higher than 0.5% in August, with the manufacturing output seeing some pickup after two consecutive months of contraction. Towards the end of this month, the Central Statistics Organisation will
release its estimates for GDP growth in Q2. However, IIP data suggests that GDP industry (excluding construction) will
grow far lower at 1.2% in Q2 compared to Q1 growth of 4%, leaving the construction sector to bring an uptick in overall
industrial growth, if any.

Manufacturing output rose by 2.5% in September, with Q2 as a whole posting near stagnation in output. In Q1,
manufacturing growth had risen to 3.9% in part due to the budgetary announcements such as extension of excise
duty cuts in auto, and consumer durables. Consumer goods output fell nearly 2.8% in Q2, with most of the
decline coming from consumer durables. Similarly, capital goods output too fell by 0.1% in Q2 compared to
13.6% growth in Q1.

Moving into Q3, currently there appear limited signs of a pick-up in demand. For instance, the festive month of
October did little to spruce up demand in the automobile sector. On a year-on-year basis, passenger vehicles
sales fell by 7.5% compared to average 7.4% growth in Q2, while two-wheeler sales fell 3.6% in October
compared to average growth of 18.9% in Q2. Commercial vehicle sales however have continued to decline
reflecting sluggishness in industry. The segment saw sales fall 3% in October compared to 3.5% average fall in
Q2.

Growth in electricity generation fell to 3.9% in September after growing at an average 13% in the preceding three
months. This decline could likely be due to a pick-up in rainfall during the month having an impact on electricity
demand. Meanwhile, mining output grew by 0.7% in September. In Q2, mining output growth halved to 1.3%
compared to 3.0% in Q1. For fiscal 2015, CRISIL Research expects iron ore production to decline by 5.5%
compared to an estimated 6.8% decline in fiscal 2014 due to non-renewal of mining leases in several mines in
Orissa and Jharkhand. These two states contribute to nearly 65% of the total iron ore production. However, coal
production is expected to grow by about 5% in fiscal 2015, compared to about 2.5% last year, primarily driven
by capacity expansion. Despite the de-allocation of captive coal blocks, production is not expected to be
impacted this fiscal as operational coal blocks are allowed to continue operations till March, 2015.

Overall this year, while investment driven sectors have continued to underperform, acute rainfall deficiency in the initial
months of the monsoon season is also likely to have dented farm incomes to some extent and hence consumption
demand. Moreover, while both household and business sentiments have continued to improve, these are yet to translate
into demand. Significant deleveraging of businesses given huge debt, excess capacities and sluggish sales are hindering
fresh investments, while households continue to hold back demand given low visibility on sustained improvement in
incomes and decline in inflation.

CRISIL Economy First Cut

Figure 3: Industry slows its pace in Q1


%, y-o-y
13.6
11.3
4.5

9.4

3.9
1.1

3.0
0.1

1.3
-1.0
-3.2
-6.1

IIP

Manufacturing

Electricity

Mining

Q1 FY15

Capital goods

Consumer goods

Q2 FY15

Source: CSO, CRISIL Research

Table 2: Sectoral Growth (%, y-o-y)


Weight

Nov13

Dec13

Jan14

Feb14

Mar14

Apr14

May-14

Jun14

Jul14

Aug14

Sep14

1,000.00

-1.3

0.1

1.1

-2.0

-0.5

3.7

5.6

4.3

0.4

0.5

2.5

Mining

141.6

1.6

2.6

2.7

2.3

0.5

1.7

2.5

4.8

1.2

2.0

0.7

Manufacturing

755.3

-2.6

-1.1

0.3

-3.9

-1.3

3.0

5.9

2.9

-1.0

-1.3

2.5

Electricity

103.2

6.3

7.5

6.5

11.5

5.4

11.9

6.7

15.7

11.7

12.9

3.9

General

Use-based classification
Basic

355.7

2.7

3.0

2.8

4.5

4.6

8.6

7.5

10.2

7.4

9.2

5.1

92.6

0.1

-2.5

-3.9

-17.6

-11.5

13.4

4.2

23.3

-3.9

-9.8

11.6

Intermediates

265.1

3.7

5.2

4.3

4.0

1.3

3.0

3.5

2.6

3.0

-0.1

1.8

Consumer
Goods

286.6

-8.9

-4.6

-0.5

-5.2

-2.2

-4.8

4.6

-8.8

-7.7

-6.5

-4.0

-Durables

53.7

-21.7

-16.1

-8.3

-9.8

-11.8

-7.7

3.6

-23.3

-20.9

-15.0

-11.3

-Non durables

233

2.2

2.8

4.6

-2.0

5.0

-2.7

5.2

1.9

2.4

-0.4

1.5

Capital

Source: CSO, CRISIL Research

4 4

Analytical Contacts:
Vidya Mahambare

Dipti Deshpande

Sakshi Gupta

Principal Economist, CRISIL Research

Senior Economist, CRISIL Research

Junior Economist, CRISIL Research

Email: vidya.mahambare@crisil.com

Email: dipti.deshpande@crisil.com

Email: sakshi.gupta@crisil.com

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Email: jyoti.parmar@crisil.com

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