By Sonal Varma & Aurodeep Nandi
Industrial production (IP) development fell to -1.6% y-o-y in January, vs an upward revised 1.6% in December (previously 1.%), decrease than anticipated. We had anticipated a slowdown in the y-o-y development due to an unfavourable base, but the sequential rise was lesser, though nevertheless positive. On a seasonally adjusted basis, we estimate that IP rose by .2% m-o-m in January vs 1.6% in December. The disappointment was primarily due to weakness in customer non-durables output development, which also fell sequentially in annual terms in January (-6.8% y-o-y). Capital goods output development rose sequentially, but its y-o-y price fell by -9.6% y-o-y in January, due to an unfavourable base. Intermediate and infrastructure goods output development rose .5% y-o-y and .3%, respectively.
Overall, the primary takeaway from the February inflation information are increasing indicators that a mixture of larger commodity costs and normalising domestic demand are resulting in larger momentum in core inflation. Looking to March, the inflation dynamics seem adverse, not least due to adverse base effects.
On the positive side, vegetable costs have surprisingly continued to contract in March (-8% m-o-m in the initial 11 days, exceeding the -5.8% recorded in February). However, the broader meals and beverage basket continues to show larger price tag pressures, led by pulses, non-alcoholic beverages, and vegetable oils. Non-meals price tag pressures are also considerable in March. LPG cylinder costs have been hiked by ~10% m-o-m, which will influence fuel price tag inflation. Higher crude oil costs have led to elevated pump costs, which will drive up transport and communications CPI as nicely as feed by way of to larger input charges.
Although the fall in gold costs must give some relief (for individual care CPI), the mixture of larger international commodity costs and increasing pricing energy of firms, in light of the cyclical development recovery, suggests larger propensity of these price tag pressures to be passed on to customers, in our view. Finally, we count on services inflation to rise as the economy swiftly normalises. Consequently, CPI inflation is tracking 5.-5.5% in March, led by each meals and core inflation – the latter is probably to rise above 6%. We count on a moderation in April to 4.-4.5% due to favourable base effects, just before inflation returns to trending at 5.-5.5% till Q3.
Overall, we count on inflation to typical about 5% in 2021, although core inflation is anticipated to typical larger at ~5.5%. Growth remains on a steady recovery path and in spite of the damaging surprise on January IP, the broader theme of normalisation remains intact, in our view. Early information for February like merchandise trade, GST, PMI and auto sales point to continued upside momentum, and our composite top indicator is also pointing larger.
Overall, activity remains on an uptrend in Q1. A essential close to-term threat is increasing pandemic situations, though this is concentrated in a handful of states (primarily Maharashtra) and is not however a pan-national second wave. Our base case remains one of an imminent organization cycle recovery, aided by tailwinds from the lagged influence of quick monetary circumstances, frontloaded fiscal activism, powerful international development and the ‘vaccine pivot’.
India has inoculated close to 2% of the population, and we count on a vaccine pivot point to be reached in Q3 this year. We project GDP development at 12.4% y-o-y in 2021, up from – 6.9% in 2020. For FY22 (year-ending March 2022), we are above consensus at 13.5% GDP development.
On policy, we sustain our base case that each policy prices (repo and reverse repo) and the accommodative policy stance will be maintained at the April 7 policy meeting. While development prospects are enhancing, the output gap is nevertheless damaging and the recovery is not however on tough foundations. Meanwhile, inflation is broadly inside the target variety, though upside dangers have risen.
RBI’s willingness to sustain accommodation can also be explained by its trilemma of controlling yields, making sure smooth absorption of the government’s borrowing, although leaning against currency appreciation, all although maintaining excess liquidity beneath manage. The balancing act has been compounded by international variables like increasing US Treasury yields and larger oil costs, which add to the upward stress on domestic bond yields.
However, we think India’s monetary policy cycle is closer to a turning point. RBI’s existing inflation outlook assumes headline inflation averaging 5.2% in H1 2021 and 4.7% in H2, but there are upside dangers to its H2 forecasts, in our view, provided increasing input price pressures. Moreover, we count on development to continue to recover and the output gap to close by Q1 2022. As development normalises, so must policy.
In the coming months, as self-confidence about the development recovery increases and core inflation momentum rises additional, we think the RBI will have to have to draw a distinction among its policy stance on prices (that reacts to the altering macro landscape) vs that of its liquidity management (which prioritises making sure orderly evolution of yields).
In our base case, we count on the RBI to preserve its policy repo price unchanged in 2021. However, we count on the procedure of liquidity normalisation to start in mid-2021, the policy stance to shift to ‘neutral’ from ‘accommodative’ in Q3 (July-September), and a 25bp reverse repo price hike in Q4. This is probably to be followed by 50bp worth of repo price hikes in H1 2022, with dangers skewed towards additional hikes.
Varma is chief economist, India and Asia ex-Japan, and Nandi is India economist, Nomura Views are individual
Excerpted from Nomura Global Markets Research’s Asia Insights report dated March 12, 2021