IIP growth in Nov’17 shot up to 8.4% yoy against our expectation of 3.4% yoy, largely on account of sharp growth in Consumer Non-durables and in Infrastructure sectors. Consumer Durables might start witnessing a turnaround in growth based on: a) increase in government spending in rural areas b) pick-up in retail credit to 17.3% and c) lower base due to demonetization last year. Momentum in Capital Goods witnessed an uptick on yoy basis, which is largely attributable to double-digit growth in CVs while Machinery & Equipment remained subdued. Although we believe that the spike in IIP growth in Nov’17 is one-off, the growth momentum in H2FY18 is likely to average ~5.5-6.5% vs. 2.6% in H1FY2018.
Retail inflation in Dec’17 moved beyond RBI’s comfort, rising to 5.2% yoy, slightly below our expectation of 5.3%. Overall build-up in inflation remained strong and was broad-based. Food and core inflation contributed largely to the uptick inflation. This increase was also attributable to the last year’s base of demonetization. We maintain our view of inflation hardening to 5.3% on an average in Q4FY18. This might prompt RBI to withdraw 25bps rate cut announced in Aug’17 by the year end.
Sharp growth in Consumer Non-durables sector
Consumer Non-durables growth rose by 23.1% yoy in Nov’17, which was on account of lower base and sharp growth in Pharmaceutical products. Pharmaceuticals & Medicine production grew by 39.5% yoy, which was largely contributed by Digestive Enzymes (2.5pps to headline growth of 8.4%). Also, food production rose by 17.8% yoy in Dec’17, which can be attributed to lower base of -7.9% in Dec’16. In line with our expectations, Consumer Durables growth turned positive at 2.5% yoy. However, Gems & Jewellery, (down by 69% yoy) and Electric Heaters (down by 37% yoy) continued to be a drag on the sector despite a favourable base. Capital Goods reported a growth of 9.4% yoy vs 6.6% yoy in Oct’17, which is mainly attributable to a sharp growth in Motor Vehicles and Other Transport Equipment, up by 17.8% yoy and 22.6%, respectively. Machinery and Electrical Equipment remained subdued.
CPI to remain above 5.0% for rest of FY18
CPI in Dec’17 rose to 5.2% yoy, slightly lower than our estimate of 5.3%. We expect the CPI reading to be beyond 5.0% for the rest of FY18. Price build-up in inflation (according to diffusion index) was not as broad-based as Nov’17. But, higher inflation reading was partly due to lower base (initial reaction of demonetization), which is also likely to be reflected in Jan’18 reading. Core inflation and core-core inflation both increased to 5.1% yoy and 5.7% yoy, respectively, which can be attributed to partial pass-through of rise in input prices and HRA implementation. Food inflation rose to 5.0% yoy, led by a sharp increase in Vegetables inflation to 29.1% yoy in Dec’17. The wedge between CPI inflation at rural and urban increased in Dec’17 to 17bps, as rural and urban inflation increased to 5.3% yoy and 5.1% yoy, respectively.
Outlook: RBI might reverse its earlier rate action sooner
Government reinforcing focus on rural sector and on reflationary spending, as further corroborated by the supplementary grants, is likely to improve the demand conditions in H2FY18. We expect IIP growth, particularly from Consumer Durables side, to be reinvigorated to an average 5.5-6.5% in Q4FY18. However, we believe a large amount of improvement in consumer demand is likely to further rely more on imports rather than substantial pick-up in the domestic production. On the inflation front, we expect CPI to increase to 5.3% yoy on an average in Q4FY18, which is much above RBI’s target of 4%. Narrowing of output gap consideration, systemic liquidity turning deficit and higher inflation might prompt RBI to withdraw the 25bps rate cut announced in Aug’17, which was largely in response to excessive liquidity and transient sharp fall in inflation.
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