PL Report: EcoFlash - A Dance of Optimism Amidst Softening Inflation and Robust Industrial Growth

A Dance of Optimism Amidst Softening Inflation and Robust Industrial Growth - Amnish Aggarwal - Head of Research, Prabhudas Lilladher Pvt Ltd.

India's macroeconomic landscape in September 2023 presents a blend of optimism and caution. The CPI inflation notably softened to 5.02% YoY, down from August's 6.83%. This decline, primarily attributed to falling vegetable prices and the LPG price cut's aftermath, surpassed market expectations pegged at 5.50%. However, while food inflation saw a near 2% drop, staples like pulses and cereals, less susceptible to rapid fluctuations, surged by 4% MoM, hinting at persistent upward pressures in the coming months.

Simultaneously, the industrial sector showcased robust growth. The IIP index hit a 14-month zenith at 10.3% in August 2023, marginally below the anticipated 10.5%. This surge was broad-based: manufacturing output soared to 9.3%, with a mere 5 out of 23 industries in decline; the mining sector maintained its double-digit growth trajectory; and electricity output nearly doubled from the previous month. The government's infrastructural push seems to be paying dividends, as evidenced by the consistent double-digit expansion in the infrastructure and construction sector.

♦ CPI inflation moderated from 6.83% YoY in Aug-23 to 5.02% in Sept-23, primarily driven by a dip in vegetable prices and the ripple effect of the LPG price cut. While market participants expected a deceleration (towards 5.50%), the actual print surprised significantly on the downside.

♦ On a sequential basis (mom, non-seasonally adjusted), headline inflation fell by 1% and food inflation was down by close to 2% in the month.

♦ Relief emanated from the food basket, which saw 1.82% MoM fall, led by Vegetables, Egg, and Meat & Fish. However, the decline in overall food inflation was limited due to continued price pressure seen from Cereals and Pulses, which witnessed a significant 4% MoM increase.

Core Inflation

♦ Core inflation (CPI ex indices of Food & Beverages, Fuel & Light, and petrol and diesel items within Miscellaneous basket), saw a decline to 4.5% YoY in Sept-23, the lowest in the post Covid period, from 4.9% in Aug-23.

♦ There was broad-based moderation across sub-categories which also indicates that the underlying consumption demand may have lost a bit of its strength.

♦ On a sequential basis, core inflation was stagnant (close to 0%) compared to 0.4% MoM increase in August.

Inflation Outlook

♦ The inflation print in Sept-23 continues to offer relief as it confirms the quick mean reversal in price of volatile food items. Going forward, this is likely to gain momentum as one moves towards the favorable food seasonality period in Q3.

♦ However, it's essential to note that inflation in staples like pulses and cereals, which historically prove more resilient than volatile vegetable prices, may persistently influence food inflation in the upcoming months.

♦ A pivotal factor shaping the inflation landscape in Q3 FY24 will be the trajectory of oil prices and their subsequent impact on domestic inflation. The price of brent crude is likely to average between $85-95 pbl for H2 FY24. While we do not expect this to translate into a hike in retail prices yet because of upcoming elections, it nevertheless diminishes the likelihood of any price cuts. Moreover, with wholesale prices likely to capture the spillover impact of higher international prices, there could be a second order impact on CPI inflation if the rising trend is sustained, given the ever-present specter of geopolitical upheavals.

♦ From monetary policy perspective, while one draws comfort from the fact that impact of outliers on inflation has started to recede, it would be premature to lower the guard on inflation amidst uncertainty on food and fuel inflation.

♦ From monetary policy perspective, while one draws comfort from the fact that impact of outliers on inflation has started to recede, it would be premature to lower the guard on inflation amidst uncertainty on food and fuel inflation.

♦ The recent data presents an optimistic outlook for the bond market, potentially driving the 10-year bond yield below its last close of 7.30% in the upcoming session. However, the trajectory of domestic bonds may be significantly influenced by the forthcoming US CPI data. A decline in US yields this week reflects the market's tempered expectations of an imminent Fed rate hike. Yet, any unexpected surge in inflation could recalibrate these anticipations. As the RBI maintains its vigilance on inflationary pressures, we anticipate a tightening of liquidity conditions. In the short term, we project the 10-year bond to oscillate within a 7.25-7.35% range.

Industrial Output Soars to a 14-Month High

♦ India’s industrial activity as measured by IIP rose to a 14-month high of 10.3% in Aug-23, from an upwardly revised 6.0% in Aug-23. The headline growth turned out to be marginally lower than market consensus which was pegged at 10.5%.

♦ On a seasonally adjusted sequential basis, industrial output rose by 1.4% after recording a decline of 1.5% in July,

♦ Industry wise, broad-based improvement was seen in manufacturing, mining and electricity. On the use-based side, broad-based improvement was seen as well with Primary, Capital, Infrastructure and Construction goods output recording double-digit growth.

♦ Manufacturing output rose to a 14-month high of 9.3% in Aug-23 from 5% in Jul-23 amid a favourable base. Only 5 out of 23 manufacturing industries posted a negative growth as compared to 19 industries in Jul-23.

♦ Mining output continued to grow in double digits in Aug-23. Similarly, electricity output growth nearly doubled (15.3% from 8.0% in Jul-23) during the month.

♦ The output in the infrastructure & construction sector expanded in double digits for the fifth consecutive. This is likely to be driven by the Government’s infrastructure spending.

♦ Consumer durables output recorded a growth after a hiatus of 2 months. Conversely, consumer non-durables continued to expand and recorded a growth of 9% YoY in Aug-23.