High industrial growth, low retail inflation signal faster growth – but is this the real picture?

The October Index of Industrial Production or IIP and the November Consumer Price Index or CPI data both indicated the economy did reasonably well in that period. The IIP rose 8.1% year-on-year while the CPI eased to 2.3% year-on-year.

Both showed improvements, on an IIP of 4.5% in September and a CPI change of 3.38% (revised estimate) in October. In the April-October period, industrial output grew 5.6% compared to 2.5% in the same period of the previous financial year.

The IIP has a strong correlation with gross domestic product (the value of all goods and services produced in a country in a year) since its components contribute to over 30% of GDP. A rising IIP should indicate accelerating growth and that means more demand for credit. Meanwhile, falling inflation gives lenders the chance to push out credit at lower rates of interest and, thus, grow their asset portfolio.

At first glance, these are great numbers that back the narrative of faster growth with more credit disbursal. But these are point-to-point comparisons that need to be examined for base effects.

The inflation numbers can be easily explained. Food basket inflation (food contributes 46% by weight to CPI) was already negative in October and turned more so in November, at -2.61 year-on-year. The fuel and light basket (8% by weight) was up 7.4%. Core inflation (CPI minus food and fuel) was running at 5.7% year-on-year, down from 6.1% in October.

The implications of rural distress on account of low food prices are disturbing, and borne out on the ground by farmer rallies across the country and Tuesday’s Assembly election results in five highly rural states. There is a good case for rate cuts at the Reserve Bank of India’s next monetary policy review in February. Low inflation combined with low GDP growth in the second quarter (July-September) makes the case stronger.

Base effects

But we do need to examine base effects to explain the Index of Industrial Production. In October 2017, the Goods and Services Tax was still experiencing severe teething troubles. Manufacturers went through phases of adjustments. In June 2017, they throttled back production because the Goods and Services Tax did not allow offsets for inventory held prior to its July 1 launch date. To compensate for this, manufacturers tried to push out more volumes post-launch. But they also ran into trouble with a working capital crunch; there were no offsets for the informal elements of their value chains until those could be formalised, and credits/ offsets were slow.

In October this year, manufacturing (which accounts for about 78% of IIP) rose 7.9% (2% year-on-year in October 2017 over October 2016). Mining was up 7% (0.2% contraction in October 2017) and power was up 11% (3.2% in October 2017). In use-based terms, construction/infrastructure was the best performer, up 8.7%. There is a base effect visible since growth was clearly low in October 2017.

The auto industry is a good proxy for overall manufacturing. It has a long value chain across industries. Using auto as a proxy, July-September 2017 saw a spike in volume as manufacturers pushed out higher dealer despatches to compensate for low volumes in June 2017. By October 2017, despatches to dealers had settled near long-term averages. These rose by 2% in October this year over October 2017, and flattened to less than 1% year-on-year this November.

In addition, adjustments are required for shifting festive seasons. In 2017, Dussehra fell on September 30, Navratri was in September and Diwali on October 19. This year, Dussehra was on October 19 and Diwali on November 7.

The IIP reports production volumes and festive holidays mean lower production. But manufacturers also adjust inventory, anticipating higher sales during festive periods. In October this year, IIP growth may have been pushed up by inventory adjustments as well as favourable base effects.

According to the rating agency ICRA, the pick-up in industrial growth in October is in all likelihood temporary, “as portended by considerable deterioration in the growth performance of the available lead indicators such as auto production, electricity generation and Coal India Limited’s output in November 2018”.

Auto production in November was flat, as mentioned above. Power generation in the same month was 99,888 gigawatt hours, 4.6% more than in November 2017 but lower than the October 2018 generation of 113,507 gigawatt hours (10.2% above October 2017).

Coal India Limited produced 52.09 million tonnes of coal in November (against 51.26 million tonnes in November 2017), but the actual offtake was 51.01 million tonnes (50.71 million tonnes in November 2017). That is a slowdown, with 0.6% rise in the November offtake versus 7.4% rise in the offtake between April and October.

Poll season compulsions

The October spike in IIP could, therefore, be a bit of a statistical aberration. If IIP drops again in November, it will bear out predictions that second-half GDP growth will not accelerate. That would make the case for rate cuts in February even stronger.

Policy-wise, the government would love lower interest rates. This would make it easier for the Centre and various states to borrow vast sums. This will be the norm, given the need to fund election freebies for every sort of political formation. In Rajasthan, Chhattisgarh and Madhya Pradesh, for instance, the new state governments are already committed to farm loan waivers, large pay commission-linked salary increases for civil servants, and power subsidies, among others.

There could be floods of easy money coming through the pipeline. There will be a price to pay, of course, since a large proportion of those loans will go sour, or be forgiven. But that price will be paid only after the next general elections in 2019, by government-owned banks that will be pushed closer to bankruptcy.