The PMI data suggests domestic demand will likely remain weak and that inflationary pressures will remain contained, which should open up space for rate cuts, says Nomura in its “Asia Insights” report

India’s manufacturing PMI fell to 50.1 in May from 51 in April, due to a sharp fall in the output and new order sub-indices. Much of this moderation is due to continued weakness in domestic demand, while export orders rose in May, said Nomura in its “Asia Insights” report.
 

Price pressures eased further as the input prices index fell on lower commodity prices. The output prices index fell below the 50 threshold mark on weak demand and lower input costs, suggesting core inflation is likely to fall in the coming months.

Overall, the PMI data suggests domestic demand will likely remain weak and that inflationary pressures will remain contained, which should open up space for rate cuts. The brokerage expects the Reserve Bank of India to implement a 50 basis point repo rate cut in H2 2013.

According to Nomura, the new orders sub-index fell sharply to 50.5 in May from 52.3 in April, even as the new export orders index rose to 54.0 from 51.1. This suggests that domestic demand weakened in May.
 

The output sub-index fell below the 50 threshold for the first time since June 2009 (to 48.6 from 50.2), indicating that weak demand, increased competition and persistent supply-side pressures are forcing manufacturers to cut production. The finished goods inventory sub-index was barely changed (50.6 from 50.7) despite weak output. The new orders/inventory ratio fell for a seventh straight month, to 1.00 from 1.03—an indication of weak future demand.

The input prices sub-index eased to a 50-month low of 51.3 from 54.1, reflecting the moderation in commodity prices. More importantly, the output prices sub-index, which has a lagged correlation with core WPI inflation, fell below 50 (to 49.8 from 51.9) on a combination of weaker demand and lower input costs, which indicates that core inflation is likely to trend down further in the months ahead, and likely at a faster pace.

Recent GDP data indicated that domestic demand considerably weakened in Q1 2013. The fall in PMI (to 50.6 for Apr-May versus 53.1 in Q1) indicates that domestic demand weakened further in early Q2 as well, dashing hopes of a quick recovery and in line with Nomura’s view that a recovery is likely to be gradual at best.

Nonetheless, weak demand and lower input costs have also helped reduce inflationary pressures. According to Nomura, weak domestic demand and lower inflation should give policymakers much needed space to lower interest rates, though a weakening currency is complicating their task. The brokerage continues to expect a 50bp repo rate cut in H2 2013. In the June meeting of the RBI, it expects repo rate to be unchanged, alongside a 25bp cut of the cash reserve ratio.