Cost-push inflation due to past currency depreciation and high food inflation is squeezing corporate margins and hurting consumers’ real purchasing power in India

India’s industrial production (IP) moderated below expectations to 0.6% in August from 2.8% in July, due to contraction in capital and consumer durables output growth, while consumer non-durables and intermediate goods output growth improved. Looking ahead, better export growth and good monsoons have raised hopes of a turnaround in the industrial cycle. However, according to economists, leading indicators do not indicate any revival at this stage and the growth in real gross domestic product (GDP) may remain below 4.2% during FY14.

"Due to past currency depreciation and high food inflation, cost-push inflation is squeezing corporate margins and hurting consumers’ real purchasing power in India. Hence, even with better monsoons, we expect non-agriculture GDP growth to slow down due to weak domestic demand, hurting overall growth. We expect real GDP growth at a below-consensus 4.2% y-o-y in FY14 (Consensus: 4.9%) and 5.1% in FY15 (Consensus: 5.9%)," said Nomura Financial Advisory and Securities (India) Pvt Ltd in a research note.

India’s IP growth moderated to 0.6% y-o-y in August due to two factors. First, capital goods output growth – an indicator of investment activity, which was bolstered last month by two volatile categories (rubber insulated cables and ship building & repairs), slumped back into the contraction zone (-2% y-o-y) after rising an impressive 15.6% y-o-y in July. Second, despite higher car production, consumer durables output growth remained in the negative, possibly due to a sharper slowdown in white goods production.

"Intermediate goods output growth – a leading indicator of final demand - also improved to 3.6% in August from 3.1% in July. If final demand does not catch up, then this could lead to increased inventories. Export driven sectors such as textile products (wearing apparel etc) registered double-digit output growth. However, overall the IP data suggest that domestic demand remains very weak with a fairly prolonged bottoming out process," added Nomura.

Dr Soumya Kanti Ghosh, chief economic adviser in the economic research department at State Bank of India (SBI) said, "IIP growth for August 2013 at 0.6% fared worse than street expectations. May 2013 figures were revised down significantly to -2.5% from -1.6%. The growth in export oriented sectors slowed down in August 2013, notably apparel & leather. The good news is that investments in new projects are showing an improvement. The bad news is that projects completed are declining, indicating that the pipeline of fresh investments is not encouraging. Additionally, the number of projects dropped is still at an elevated level, indicating that the investment climate may not be witnessing any palpable signs of revival."

According to Nomura, better export growth and good monsoons have raised hopes of a turnaround in the industrial cycle. "In our view, leading indicators do not indicate any domestic demand revival at this stage. The OECD’s composite leading index for India continues to plummet. Production of medium and heavy commercial vehicles (MHCV) – an indicator of industrial and capex activity – has worsened: from a contraction of -2% y-o-y in Apr-May, MHCV output growth fell -54% y-o-y in September. Both the manufacturing and the services PMI have worsened in Q3 as compared to Q2. Export growth has indeed improved in Q3, but the export new orders index (of the manufacturing PMI) has softened, raising doubts about the sustainability of this momentum."

In addition, policies are turning pro-cyclical with both fiscal and monetary policy being tightened despite a sharp slowdown. Even as the Reserve Bank of India (RBI) has cut the marginal standing facility rate, which will lower the short-term working capital costs, the repo rate – which determines the medium-term interest cost, was hiked in September. The government’s fiscal deficit has reached 75% of the full year budget target during the first five months.

"This means an impending belt-tightening akin to last fiscal year (cut in spending and delay in payment during the next six months till March, in order to get closer to the budgeted fiscal deficit target. Additionally, cost-push inflation due to past currency depreciation and high food inflation is squeezing corporate margins and hurting consumers’ real purchasing power. Hence, even with better monsoons, we expect non-agriculture GDP growth to slow down due to weak domestic demand, hurting overall growth," Nomura added.