Twin challenges in the year ahead…

From a macro economic perspective, the previous week was surely disappointing for the Indian markets. The reasons were not far to seek. On the one hand, CPI inflation touched the critical 5% mark for the month of June. At the same time the IIP growth for the month of May 2018 came in sharply lower at just 3.2%. In the midst of these economic disappointments, the other macro concerns like rising trade deficit, global trade wars and a weakening rupee continue to haunt the economy.

CPI voices concern…

Retail inflation (CPI inflation) measured at 5% for the month of June. In the last RBI Policy Meet, the MPC had voiced concerns that inflation could become a real challenge if it crossed and stayed about the 5% mark. The worry is that the rise in inflation is largely driven by non-food items like fuel and lighting. That is more due to the sharp rise in the price of crude oil in the Brent market. Food inflation has almost remained flat but that is hardly reason to rejoice. The government had announced minimum support prices (MSP) for Kharif farmers at 150% of the total cost of production. This was implemented in early July with the government announcing the actual prices for Kharif crops. Most of the prices are way above expectations. While the final price will still depend on procurement, the inflation effect from food cannot be denied in the coming months. That is a challenge!

IIP disappoints a tad…

If inflation was one side of the story, the other side of the story is growth. The index of industrial production (IIP) has come in sharply lower at 3.2% in May 2018 as against 4.9% in the month of April 2018. Street estimates for the IIP growth in May 2019 were closer to 4% so the actual number turns out to be really disappointing. The slowdown in IIP growth was driven by a mere 2.8% growth in the manufacturing sector which is the key driver of IIP with over 70% exposure to the IIP basket. Manufacturing got hit by higher input costs and lower volumes due to liquidity shortfalls in many quarters. The lead indicators like the capital goods production also disappointed for the month of May 2018.

What happens to rates?

That brings to a very fundamental question; what happens to repo rates? Clearly, the repo rates are not going to be cut in a hurry. The bigger debate is between flat repo rates and a more hawkish approach. A lot would predicate on how inflation pans out in the next few months. Crude inflation may continue to remain at elevated levels. The real difference will be made by food inflation which will depend largely on how the MSP impact pans out in the Kharif season. If food inflation perks up, then another rate hike in the month of October could be on the cards!