Demonetisation Effect: Inflation Cools to 2-yr Low in November

India's retail inflation eased significantly last month after Prime Minister Narendra Modi's shocking demonetization drive dented the consumer spending, fuelling hopes of an interest rate cut by the Reserve Bank of India at its next policy review in February 2017.

According to the data released by statistics office, consumer inflation, the benchmark price gauge of the RBI eased to its lowest level in two years to 3.63 per cent in November from 4.20 per cent in October. It was 5.41 per cent during the corresponding period last year.

The fall in in the inflation was primarily due to sharp slowdown in food prices which registered its fourth consecutive month of decline, coming in at 2.11 per cent in November from 3.32 per cent in October.

In addition, Inflation rate based on wholesale price index (WPI) also decelerated for the third consecutive month to 3.15 per cent in November from 3.39 per cent a month ago, as a squeeze in cash availability impacted prices of perishable commodities.

Prime Minister Narendra Modi's shocking move to cancel 500-rupee and 1,000-rupee banknotes, which accounts for 86 per cent of the cash circulating in Asia's third-largest economy, has disrupted daily life, discouraging consumer demand. The slow pace of replacing the old currency with the new Rs 500 and Rs 2,000 banknotes is expected to have led to the demand compression, which has eventually hit the small businesses.

November's reading is way below the Reserve Bank of India's (RBI) 5 per cent inflation target for March 2017 as well as the medium-term target of 4 per cent. The monetary policy committee headed by RBI Governor Urjit Patel had earlier this month held interest rates steady and said demonetisation of high value currency notes could lower prices of perishables and reduce CPI inflation by 10-15 basis points by December.

With this sharp slowdown in inflation, there is room for further rate cuts by RBI in the next policy meeting. However, before penciling in RBI's next move, the economists are eyeing the advance estimates of GDP and the December CPI numbers.  

Latin Manharlal Group

Demonetization: Short-Term Pain but Long-Term Gain

Taking the whole country by surprise, Narendra Modi has pulled off a shocking move to demonetize higher value currency notes as he waged war on the evil of black money in Asia’s third biggest economy.

While it’s hard not to overlook the short-term repercussions of wiping out Rs 500 and Rs 1000 notes which comprise 86 per cent of total value of currency in circulation, the long-term implications of demonetization are seen as positive.

Demonetization has sent out a strong message about the country’s anti-corruption drive which will improve investment sentiment in the long-run.

While the sudden cash crunch may have crippled the common man, demonetization marks a crucial step in India’s bid to transform into a cashless economy.

With cash-intensive sectors such as food, transport, real estate and restaurants likely to be severely hit, this fiscal’s GDP could be squeezed by 0.8 to 1 per cent. In the longer term, demonetization may help bolster economic growth as more and more of the informal economy becomes formal and the Goods and Services Tax comes into play.

Successful unearthing of unaccountable money could propel tax gains for the government, good news for India’s fiscal deficit.

An interest rate cut also looks likely on the cards in the coming months as a cash squeeze exerts downward pressure on consumer food prices amid lower purchases. Lower borrowing costs will augur well for India Inc. particularly rate-sensitive sectors such as auto and banking. Also, the withdrawal limits on cash will propel faster growth of bank deposits, supporting lower long-term deposit and lending rates.

 Looking beyond the long queues outside banks and ATMs, wobbly stock markets and short-term consumption & growth squeeze, Modi’s latest reform is a well-thought out one. The key to its success lies in its implementation.

The bottom line -No gain without pain!

Latin Manharlal Group

Uptick in Manufacturing PMI underpins India’s Economic Recovery

India’s factory activity expanded at its fastest pace in almost two years in October, with a robust rise in new orders as well as output, supporting the strong growth story of the Asia's third largest economy.

According to a Markit Economics report, Nikkei India Manufacturing Purchasing Managers’ Index, a gauge measuring activity in the manufacturing sector spiked up to 54.4 in October, a 22-month high, from September's 52.1, marking the biggest monthly jump in almost five years, with a reading above 50 signaling expansion.

The manufacturers attributed the latest rise in production to solid growth of the new orders, which surged significantly in October, pointing towards the strength in the underlying demand.  While, foreign orders continued to contribute to the upturn in the total new work, the rate of growth in new businesses from overseas eased to a three-month low.  

Meanwhile, the output increased for the tenth straight month and at the quickest rate in nearly four years in October.  The output sub-index, which measures the overall production, was at 57.2 in October, the highest since December 2012, and up sharply from 53.3 in September, the report noted.

The survey showed that consumer goods producers outperformed their intermediate and investment goods counterparts, registering stronger rates of expansion for both output and new orders. Despite the robust growth in new work, employment sub-index was left unchanged. Meanwhile, buying levels grew at their strongest rate in 14 months, while stock levels increased at the fastest pace since July 2015.

Moving ahead, input costs grew at its fastest rate since August 2014, part of which was passed on to the consumers by way of higher selling prices. It is likely to continue on an upward trend. This shows that risk of inflation is gathering steam yet again which had cooled to a 13-month low in September due to moderating food prices.

The increase in the inflation rate will also affect the prospects of any further easing from the Reserve Bank of India (RBI), which earlier this month surprised markets by cutting its benchmark repo rate by 25 basis points to 6.25 per cent. The next meeting of the Monetary Policy Committee (MPC) is scheduled on December 6 and 7.

Latin Manharlal Group

Softening Inflation offers scope for another Rate Cut in FY’17.

Benign inflation numbers and likelihood of a dovish monetary policy committee stance leaves the door open for further monetary policy easing this fiscal. The move could fuel additional growth by supporting government’s effort to boost economic growth to above 8 per cent to create job opportunities.

The sharp retreat in consumer inflation to a 13-month low at 4.31 per cent in September 2016 from 5.05 per cent in August 2016 is indeed a good reason for cheer, particularly when the festival season is round the corner. Retail inflation, the RBI’s benchmark price gauge has fallen below the tolerance level, leaving scope for a reduction in policy rates. The government had recently notified an annual inflation target of 4 per cent plus or minus 2 percentage points.

Further, India's wholesale prices cooled in September after touching a two year high in August. WPI inflation in September was 3.57 per cent compared with 3.74 per cent in August. Similar to retail inflation, the drop in wholesale inflation is attributed to easing food prices. Good rains kept a lid on food prices as food inflation moderated to 5.75 per cent year-on-year in September 2016 and lower than 8.23 per cent in the previous month.

The recently formed Reserve Bank of India Monetary Policy Committee, under new Governor Urjit Patel, slashed the rates by 25 basis points to 6.25 per cent in a surprise move on October 4, 2016, after inflation hit a five-month low in August.

The change in the RBI’s policy position with respect to the cut in real interest to 1.25 per cent from the 1.5 per cent -2.0 per cent range along with expanding the time to achieve 4 per cent inflation by three years to March 2021 from March 2018 provides with additional room for monetary easing in the near-term.

Since the start of 2015, the RBI has cut 175 basis points from its key repo rate. But, after the next expected cut to 6 per cent, the central bank is now projected to hold rates steady for the rest of the 12-month survey horizon.

A rate cut from here-on would help the Indian government in its efforts to lift the economic growth to above 8 per cent. It was last measured at 7.1 per cent in the March-June quarter from 7.5 per cent in the year ago period.

Latin Manharlal

India’s factory activity moderates in September

India’s manufacturing activity has moderated in September indicating that the growth in the sector has lost some momentum, creating a case for a reduction in interest rates by the Reserve Bank of India.

According to a Markit Economics report, Nikkei India Manufacturing Purchasing Managers’ Index, a gauge measuring activity in the manufacturing sector stood at 52.1 in September compared to 52.6 in August, with a reading above 50 signaling expansion in the manufacturing activity over the previous month.

The activity in the Indian manufacturing industry eased slightly in September but the output is still rising at a decent pace and the sector looks likely to have delivered a stronger contribution to the GDP growth in Q2 FY2016/17, with the quarterly reading for the PMI’s Output Index up from 51.4 during April-June to 53.6.

The biggest area of strength for factory growth was the external demand as firms witnessed robust surge in new export orders since July 2015, supported by the growth in output and purchasing activity, while new improved client demand also supported the upswing in order books.

As far as prices of manufacturing goods are concerned, the survey noted that the average purchase costs increased at a faster pace in September, but one that was weak compared to its long-run trend. Data implied that manufacturers attempted to protect profit margins as output charges were raised further.

Despite ticking higher, the rate of inflation was historically muted and it has given the central bank enough room to ease policy further. The Reserve Bank of India in its monetary policy review today slashed its key lending rate or the repo rate by 25 basis points to a six-year low of 6.25 per cent, from 6.5 per cent.

Consumer inflation in India cooled sharply to 5.05 per cent in August, almost at the RBI's March 2017 medium-term target of 5 per cent, and with favorable monsoon rains, it is expected to tread lower in the coming months.

Indian economy projected to grow 8%

Despite registering a tepid growth in the April-June quarter, Asia’s third biggest economy is expected to gain strength amid broadening of the domestic consumption base, maintaining its tag of the world's fastest growing large economy.

American rating agency, S&P Global Ratings, has projected that Indian economy will touch 8 per cent growth over the next few years supported by the ongoing momentum in India’s structural reforms, most recently with the passage of the goods and service tax (GST).

The newfound faith in the Indian economy is largely backed by the measures taken by the Modi government since taking office in May 2014. India has now successfully managed to improve its competitiveness and ease of doing business rankings. Reforms like passage of GST is expected to remove the cascading effects and the inefficiencies created by different layers of taxes across states and the central government.

Easing of restrictions on Foreign Direct Investment (FDI) will now foster productivity growth in some sectors. The bankruptcy law, improved access to bank accounts and measures aimed at easing business starts would surely push up the economic growth.

Further, a normal monsoon in fiscal 2017 is expected to give thrust to the agricultural growth, pushing it above the trend level, given the current low base due to two successive monsoon failures. This should lift the sagging rural consumption demand and boost the overall GDP growth. Fortunately for India, weather forecasters accord a higher probability for normal monsoon.

However, inflation still remains a risk, given the large weights on food, fuel, and other volatile items in the Reserve Bank of India's target basket. In terms of the monetary policy framework, the Government of India has notified a CPI inflation target of 4 per cent, within a tolerance band of 2 per cent-6 per cent until March 2021. Such a scenario would help to anchor inflationary expectations. In addition, a favourable base effect as well as an improved crop sowing dynamics will ensure that CPI inflation remains within this tolerance band in the near term.

Going forward, growth in fiscal 2017 will also find support from higher pensions announced by the government, coupled with above-average monsoon and lower interest rates.

Latin Manharlal

India’s Q1 GDP Growth Slows

Indian economy grew at its slowest pace in two years in the April to June quarter, amid sluggish investment and farm output, potentially making the government’s target of achieving 8 per cent growth this year more daunting.

Gross Domestic Product (GDP) in India rose by 7.1 per cent in the first quarter of FY 2016-17 from 7.5 per cent in the year ago period, data released by the statistics office showed.

The previous low was 6.6 per cent GDP growth recorded in the October-December quarter of the 2014-15 fiscal.

The slowdown was primarily attributed to lower activity in farm, mining and construction sectors. Mining dipped into negative territory (-0.4 per cent) and construction disappointed (1.5 per cent). During the same quarter last year, these sectors grew 8.5 per cent and 4.5 per cent, respectively.

The dwindling private investments also took a toll on India’s growth number. The Gross Fixed Capital Formation which is an indicator of investment activity in the economy, fell 3.1 per cent in real terms in the April-June quarter, signaling that the private investment sentiment remained weak. The decline in investment is despite government pushing public investment. This can be due to excess capacity in the private sector and a high level of debt in sectors such as construction and infrastructure.

Private consumption, the major driver of the country’s economy, also grew at a weaker pace of 6.7 per cent against 6.9 per cent, the year before. However, growth in this segment may improve over the next few months in the wake of a better monsoon and increase in the wages.

However, even with lower-than-expected growth, India remains the fastest growing major economy, with China registering 6.7 per cent growth during June quarter. The sectors that supported India’s economic growth included, manufacturing (9.1 per cent) and electricity (9.4 per cent), performing better than the same quarter a year ago. Agriculture and services more or less managed to stay in the positive zone.

Going ahead, good monsoons combined with pay hikes to the central government employees are likely to push economic growth in the remaining quarters of 2016-17.

Latin Manharlal