Economy beginning to look good with IIP at 7%, CPI inflation at 5-month low, but not time to lower guard yet

The two economic releases which herald the end of the financial year augur well for the economy where there was enough skepticism given the recent controversies in the banking system. Inflation appears to be within control while industrial growth looks like being in a higher range at least till the end of the March. This is good news.

Inflation is an important variable not just from the point of view of the higher cost of living but also plays a role in affecting monetary policy given that the MPC uses this number to guide its decisions. At 4.3 percent, the CPI inflation number is on expected lines with the same forces playing their roles. It has been maintained at a lower level mainly due to the lower food prices with pulses in particular driving inflation down. This should be the trend for the next few months for sure as the rabi crop is expected to be satisfactory notwithstanding some damage to the wheat crop on account of the unseasonal rains in April in the north.

However, the future trajectory will be driven by three factors. The first is the level of increases in MSP to be announced. While the impact would be more likely in the second half, the initial traces of its influence would be felt once they are announced. In a pre-election year, there could be a tendency to announce higher MSPs to ensure that farmers are rewarded well which could spike inflation even in case the normal monsoon leads to a good harvest. It may be remembered that in 2017 a good monsoon led to a good crop but prices crashed leading to farmer distress.

The second factor would be oil prices. The current imbroglio in the west does not augur well for oil prices which have been increasing of late. While the spiral will stop once the level is reached when shale production starts, a level of $70 would be the range for the next three months. The government is not keen on cutting duties or subsidizing fuel products which will mean higher inflation.

Third, prices of other products like clothing, recreation, power, housing will remain elevated. Presently companies have lost their pricing power in depressed economic conditions. In case of a recovery, an increase in prices may be expected which will push up prices. Therefore, an inflation rate of 4.5-5 percent may be expected in the first half of the year which can increase to beyond 5 percent in second half. The core inflation for March was still above 5 percent which means that any increase in food prices will push the number up further.

The joker in the pack would be the fiscal deficit because any increase in the number will get reelected in excess demand conditions and rising inflation. Hence, while the Reserve Bank of India (RBI) will not be increasing rates presently – in fact the market expects a cut given the tone taken by the RBI, the same may be expected in the second half.

Industrial growth too looks good this time and the fact that growth has been over 7 percent for four successive months is indicative of a turnaround. A part of the reason could be the bunching up of demand towards the end of the year as output slumped following GST. The destocking and restocking exercise coupled with revival of pent up demand may be factors driving growth in this period. But nevertheless, this is a good sign as it is broad based across most sectors. In fact, both capital goods and consumer goods have done well in February which is a healthy sign. Admittedly capital goods have been driven by vehicles and less by machinery which may be the missing link here. But other sectors like non-metallic minerals, electronics, metals, pharma, food etc, have done well consistently which should have positive impact on the performance of companies in Q4-FY18.

For the entire year it may be expected that growth would be around 4.6-4.7 percent assuming a similar growth of 7-8 percent in March. This is satisfactory though not exciting but would be a good base to work on in FY19.

Assuming no major disruption through policy, the missing links would be surge in consumer demand and improvement in private investment. Both these factors will have to be monitored closely and the second half of the year would be critical. This is where the monsoon, good crop and higher MSP will play a positive role in driving rural demand which in turn can help induce investment when supported by urban demand too.

Several indicators for the economy appear to be showing signs of improvement which gives reason to be sanguine about next year. a good harvest coupled with steady industrial growth can be a recipe for higher GDP growth. However, this number is not expected to be more than 7.5 percent which means that the pace of acceleration will be gentle in FY19. Crude oil and monsoons are the risk factors presently which can upset calculations and would have to be monitored closely especially on the prices front. Corporate India also needs to invest more especially in infra and this can be a cog because the banking system is not prepared to support the same. therefore, while the real sector appears to be posed to do well, the financial sector has to strengthen fast or else there could other sets of challenges for the economy.