Economy
“India’s growth recovery to remain shallow”

India’s macro-economic data, just released, suggests that the economy is facing severe supply-side constraints, which is leading to the odd combination of weak domestic output, high and sticky inflation and a widening trade deficit, says Nomura

 
Economic data, released on Monday, show negative industrial output growth, high and sticky inflation and a record-high trade deficit, led by improving non-oil imports. The latter is not consistent with a slowing economy, says Nomura research in its Asia Insights. The brokerage believes that industrial output data may be exaggerating the growth slowdown, but power outages have also constrained production. Meanwhile, the higher trade deficit reflects weak exports, a seasonal rise in gold demand and also a genuine improvement in imports due to import substitution. Overall, the data suggest that the economy is facing severe supply-side constraints, making it imperative to ease bottlenecks. Until then, Nomura expects India’s growth recovery to remain shallow as the economy will be quick to hit a ceiling. Moreover, India’s external situation remains very worrying. Nomura sees upside risks to India’s current account deficit forecast (of 3.8% of GDP in FY13) with current trends suggesting that that the deficit could be as high as in FY12 (4.2% of GDP).
 
All in all, data suggests that the economy is facing severe supply-side constraints, which is leading to the odd combination of weak domestic output, high and sticky inflation and a widening trade deficit. This makes it all the more crucial to hasten the process of land/environmental clearance and speed up the setting up of the National Investment Board, says Nomura but is there enough of political will for it?
 
Nomura has highlighted that India’s current account deficit (CAD) should rise to around 4.9% of GDP in Q3 CY 2012. However, the October trade deficit data suggests no turnaround is yet in sight. With a worsening trade deficit and high and sticky inflation, the monetary policy cannot be eased very aggressively. Nomura continues to expect a 50 basis point (bp) repo rate cut in H1 2013, with policy rates likely to stay on hold after that.
 
India’s macro-economic data paints a puzzling picture. Industrial production (IP) growth contracted 0.4% y-o-y (year-on-year) in September (2.3% in August). However, CPI inflation remained sticky at 9.75% y-o-y in October (9.73% in September) and the trade deficit widened to an all-time high of  $21 billion in October from $18.1 billion in September due to weak exports (-1.6% y-o-y in October versus -10.8% in September) and stronger imports (7.4% versus 5.1%). The latter is not consistent with an economy that is slowing sharply. To understand this disconnect, Nomura makes the following five points:
 
Power outages disrupt output: The negative surprise in IP data largely owes to contraction in capital goods (-12.2% y-o-y in October versus -3.4% in September) and consumer durables output growth (-1.7% versus 0.6%). While firms usually build inventory pre-festival seasons in October/November, Nomura believes that power outages may have constrained production this year, resulting in firms drawing down on inventory to meet demand. In addition, consumer non-durables output growth moderated sharply (1.1% versus 5.8%) reflecting lower summer crop production.
 
Growth is bottoming out, not falling: Growth in the intermediate goods output, a precursor to final demand, remains positive and, on a three-month moving average (3mma) basis, IP growth rose 0.5% y-o-y in September from a trough of -0.7% in May. Excise tax collections are accelerating, up 17.5% y-o-y (3mma) in September from 0.3% in April. Import growth, excluding oil and gold, is also trending higher. Therefore, Nomura believes that the IP data may be overestimating the growth slowdown. More likely, Nomura believes that the industrial cycle is bottoming-out. Unlike the past, Nomura expects a longer period of consolidation in this cycle due to weak exports, lacklustre investments and moderating consumption demand.
 
Reasons behind higher trade deficit: While weak exports are partly responsible, higher oil prices are not. Nomura estimates that the oil trade deficit (exports minus imports) has widened only marginally to $9.9 billion in October from $9.5 billion in September, while the non-oil trade deficit has worsened to $11.1 billion from $8.6 billion. This is partly due to the pre-festival seasonal rise in gold imports—the trade deficit worsened by an average of $3.8 billion between September and October during the last three years. However, the trend in imports ex-gold is also clearly higher.
 
Reasons behind sticky CPI inflation: Food inflation has moderated marginally to 11.45% y-o-y in October from 11.75% in September. But within this aggregate, cereals and pulses prices are rising sharply, while fruit and vegetable prices have moderated. The government’s wheat procurement program has created an artificial scarcity in markets pushing up prices, while pulses prices have risen due to lower output. Meanwhile, core CPI (ex-food and fuel) has remained unchanged in the 8.3-8.4% y-o-y range for three months now.
 
Import substitution: The phenomenon of rising imports and lower domestic output can also be explained by increasing import substitution as a result of supply-side constraints (including in power) and elevated inflation (high domestic cost of production). Electrical machinery, rubber products and consumer durables are a few sectoral examples. 
 

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