IIP May: Improves, but weakness persists
As regards the monetary policy, Edelweiss' reiterate that contained demand pressures, a below‐par economic activity, sharply weakening global economy and associated softening in global commodities provide room for additional monetary easing and accordingly, expect RBI to deliver 25bps repo rate cut in the forthcoming policy meeting.
Industrial growth better than expected
May IIP numbers came in at ~2.4% YoY, better than the consensus expectation of 1.8% and Edelweiss' expectation of 2.2%. Meanwhile, April data was revised marginally down to ‐0.9% YoY compared to 0.1% YoY reported earlier. A pick‐up in activity was observed during May in most industry segments on a YoY as well as sequential basis. However, monthly IIP data has been unusually volatile and therefore should be seen on the trend basis (seasonally adjusted 3MMA) which clearly shows that industrial activity continues to remain weak. Domestic policy hurdles, tight monetary conditions and weak external environment are all weighing on the business sentiment.
Importantly, even as the weakness in industrial output sustains, there are some positives emerging including the even strength in HSBC PMI over the last few months and pick‐up in cement dispatches. Therefore, one can expect an improvement in the activity in the coming months though for a sustained turn‐around, an improvement in the business climate through faster government approvals and monetary easing is required.
Manufacturing sees a modest improvement
Manufacturing growth in May inched up to ~2.5% YoY compared to ~‐1.2% in April due to a pick‐up in capital goods. However, on a trend basis, manufacturing sector continues to remain in slump, reflecting the general slowdown in the economy. Mining activity again saw a contraction, for the 10th month in a row, largely reflecting huge regulatory hurdles faced by the sector. The pace of contraction, however, has slowed. In the coming months, a jump in the mining output can be expected as coal production this year is likely to be much better than last year. Meanwhile, the growth in electricity production though still slow has been improving since last two months.
Among eight core industries, cement (11.3% YoY) and coal (~8.0% YoY) saw a strong growth while natural gas (‐10.8% YoY) and fertilizer (‐15.1% YoY) witnessed a steep decline
Investments still remain very weak
Capital goods production improved to ‐7.7% YoY in May from ~‐19.6% in April, showing a pick‐up sequentially. However, given the volatility in capital goods output, we have considered the more stable 3MMA basis which clearly indicates that the slump in investment has been quite deep and prolonged. This has shown a negative growth for the past eight months in a row. The severity of the downturn is well reflected in the fact that capital goods production has seen an average contraction of 10% YoY in each of past 8‐9 months. Three major factors that led to the impasse in investments are aggressive monetary tightening, weak external environment and regulatory hurdles.
Going forward, as one of the overhangs, monetary policy is likely to ease on an accelerated basis, one may see some improvement in the business confidence, particularly at the SME level. Hence, a pick‐up in investments cannot be ruled out in H2FY13. Nonetheless, policy issues remain a key bottleneck and unless those are addressed, investments will remain subdued.
Consumer durables see an uptick
Consumer goods segment has seen an improvement during the last two months, largely led by a growth in durables output although non‐durables continue to remain sluggish. However, in the coming months, rural consumption (the main stay of the activity off late) could face a weakness due to the possible deficiency in monsoon.
Policy support critical for business cycle turnaround
In toto, while the IIP number shows an improvement on a sequential basis, the overall industrial production remains vulnerable. The clear uptick in IIP observed late last year has not sustained as a trend. Several reasons account for this decline including the tight monetary policy, weak external environment and policy issues.
With regards to the monetary policy, despite a somewhat hawkish commentary by the RBI in the last policy meeting, Edelweiss' reiterates their view that the central bank should cut rates aggressively to support the faltering economy. They stress that the economy is operating far below its potential and businesses are losing the pricing power. At the same time, real interest rates currently are at much elevated levels which will continue to hinder the economic activity in the coming months. Therefore, Edelwiess expects additional 75bps rate cuts for FY13 including a rate cut in the forthcoming monetary policy review on July 31.
This aggressive monetary easing by RBI is likely to aid investments and sentiments. But, for a meaningful pick up in the investment cycle, easing will have to be accompanied by government actions aimed at resolving key policy hurdles/issues that are blocking investments.
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Edelweiss is one of the leading financial services company based in Mumbai, India. Its current businesses include investment banking, securities broking and investment management. They provide a wide range of services to corporations, institutional investors and high net-worth individuals.
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