Economy: Recovery incomplete, price rise a concern

The monthly data released on inflation and industrial production last week paints an encouraging picture of the state of the economy. However, a closer look at the numbers shows that a full recovery is still some distance away, even as inflation concerns exist despite a dip.

The consumer-price index-based inflation, or retail inflation, grew by 5.59 per cent in July after printing over 6 per cent for two consecutive months in April and May, as supply conditions eased. Food prices, which account for nearly half of the inflation basket, rose at a much slower pace - 3.96 per cent on y-o-y in July compared to 5.15 per cent in June. Core inflation moderated, though it remained elevated at 5.7 per cent compared to 6.1 per cent in the month before.

The CPI inflation is the yardstick used by the Reserve Bank of India (RBI) for policy-making purposes, and it has the mandate to keep inflation at 4 per cent with a variation of 2 per cent either side.

The worry on the price front is that inflation is seen closer to the upper tolerance limit of 6 per cent in the current financial year. The six-member monetary policy committee of the RBI revised the inflation forecast sharply upward to 5.7 per cent in the August policy review meeting (higher than consensus estimate) compared to 5.1 per cent projected in the previous meeting in June.

"India's inflation remains largely driven by non-domestic factors and will remain a core policy headache in the coming months," said Rahul Bajoria, chief India economist, Barclays.

"As demand conditions normalise following the end of the second wave, the risks of firms passing on higher input costs to consumers will rise somewhat, which will need to be navigated by the RBI in the coming months," Bajoria said. Barclays expects inflation to average 5.4 per cent in the current financial year.

Sreejith Balasubramanian, Economist – Fund Management, IDFC AMC, said that the price momentum of core inflation continued to stay strong. He said it would be vital to track any sustainable recovery in demand that typically creates price pressures that are more sticky but responsive to monetary policy, unlike supply-side pressures.

"The path of food prices which are witnessing a mild softening in certain categories of late, sector-specific supply adjustments, services inflation alongside manifestation of pent up demand, commodity prices and the path of the pandemic will be equally crucial," Balasubramanian said.

While the central bank sees the spike in inflation prints as transitory, there was a disagreement among members of the MPC in the August meeting on maintaining the accommodative stance of the monetary policy. Jayanth Varma, one of the members of the MPC, did not vote for keeping the accommodative stance, in contrast with the other five members. The central bank continued to signal "whatever it takes to revive growth" approach even if the market interpreted measures in the August policy as a signal that a withdrawal of the ultra-loose monetary policy has kicked in.

Nomura's research analysts said the lower headline inflation in July fits with the RBI's guidance of continued policy accommodation while adding interest rate hikes to start as early as the next quarter.

"In our view, the August policy meeting already bore initial signs of a policy pivot via calibrated liquidity normalisation. We believe this will be followed by the phasing out of durable injectors of liquidity, a 40bp reverse repo rate hike in Q4 [Oct-Dec] and 75bp of repo/reverse repo rate hikes in 2022," the Nomura report said.

That is precisely the worry that policymakers face today. Interest rates were cut sharply and were kept low to support growth since the pandemic broke out, often ignoring the price pressures.

But how long can such a policy continue even if growth continues to remain sluggish – notwithstanding the RBI Governor's repeated assurance of continuing the accommodative stance until a sustainable recovery of economic growth. The bond market has started aligning itself with the macroeconomic fundamentals, as evident from the inching up of the yields.

India's industrial production grew 13.6 per cent in June from the year-ago period due to the low-base effect though the impact of low-base declined in June compared to the previous two months.

The cumulative growth during the first quarter of the current financial year was 45 per cent, compared to a contraction of 35.6 per cent during the same period a year ago – when the entire country faced a strict lockdown in the last week of March 2020.

Factory output, however, remained nearly 7 per cent lower than April-June of 2019-20, that is the pre-Covid level.

While most industries have witnessed healthy increases in June, the index at 122.6 for IIP was lower than that in 2019 when it was 129.3. For manufacturing, it was 129 and has come down to 121. "Clearly, there is a long way to go for the IIP," said Madan Sabnavis, Chief Economist, Care Ratings.

Industrial production moderated to 13.6 per cent y-o-y in June from 28.6 per cent in May. Still, it rebounded by 8.6 per cent on a month-on-month basis from -11.5 per cent in May, reflecting the easing of restrictions and recovery in economic activity. Though there are signs that recovery has begun, factory output in June was lower than April 2021 levels indicating a fuller recovery is yet to occur.

"With restrictions being eased across the country, mobility indicators have improved materially, and the economic recovery is gathering momentum. Indicators such as freight movement and merchandise exports have already returned to their pre-second-wave levels, while clear signs of recovery are visible in auto production, core sector output and electricity generation," Barclay's Bajoria said.

There are expectations that recovery will gain momentum in the coming months unless another break is imposed.

"We remain optimistic on GDP growth, and given the gradual rise in vaccinations, steady global growth, easy financial conditions and fiscal activism, maintain our GDP growth projection of 10.4% y-o-y for FY22," the Nomura report said. It added that the third pandemic wave remains the most potent downside risk to growth in the near term. The only way to minimise the impact of a possible third wave is to accelerate the pace of vaccination.

A report from the State Bank of India observed that vaccination had gained momentum in the last month, with "rural India leading from the front."

"Vaccination in rural areas has increased significantly in the case of certain states including Andhra Pradesh, Gujarat, Haryana, MP, Odisha and UP… States like West Bengal, Maharashtra and to some extent Tamil Nadu need to push up vaccination in rural areas as a percentage of new cases from rural areas have picked up momentum," said Soumya Kanti Ghosh, Group Chief Economic Adviser of SBI in the report.

(The writer is a Mumbai-based journalist)

Disclaimer: The views expressed above are the author’s own. They do not necessarily reflect the views of DH.