CRISIL First Cut

Inflation douses, IIP contracts

September 2016

Inflation fell to 5% in August after rising for four consecutive months to 6.1% in July. This was driven by a sharp drop
in food inflation to 5.9% (-250bps) - especially in vegetables, core inflation edged down to 5.0%. Further, the monthly
momentum in food inflation also slowed down - indicating a decline in prices in August. As expected, we think the
positive impact of a favourable monsoon this year is starting to reflect in lower food prices. Going ahead, this trend
is likely to continue - supported by steps taken by the government to manage food supply. Latest data suggests
rainfall is normal (-5% of LPA as of September 11), which has helped raise reservoir levels and supported sowing.
Sown area coverage so far is higher by 44.0 lakh hectare than normal as on date (as of September 2), with substantial
progress in pulses.
After the Reserve Bank of India (RBI) kept its policy rate unchanged at 6.5% at its August 9 meeting, this
increases chances of a rate cut in October. But RBI might chose to wait for some more time before wielding the
knife. We expect the average CPI to stay close to 5% this fiscal, assuming a favourable monsoon with adequate
temporal and spatial distribution. The resulting lower food inflation will offset higher services inflation. Risks to inflation
could emanate from: 1) High protein inflation, which has recorded double-digit growth for 14 consecutive months; 2)
Service inflation, especially in rural areas, which is keeping core inflation high and sticky; 3) Surprise pick up in oil
prices.
The volatility and dated base of IIP reduce its signalling ability. Keeping with the past trends, it again surprised on
the downside in July. After rising in the previous two months, inducing optimism about industrial recovery, the index
of industrial production (IIP) again fell back in the negative zone. In July, IIP declined by 2.4% on-year, a sharp
reversal from Junes 2.0%. The weakness was seen across the board. While mining (0.8% growth) and electricity
(1.6% growth) hardly grew, manufacturing sector - the mainstay of IIP with ~75% weightage registered a growth of
-2.4%. Manufacturing sector had grown marginally positively in each of the previous two months. The use-based
classification doused hopes of revival in investment revival anytime soon. The fall in the growth of capital goods
category intensified, reaching a record low of -29.6% in July. Growth in consumer goods too slowed down, but
remained positive at 1.3%. Within consumer goods category, while durable goods growth displayed continued
improvement (5.9% growth in July), growth in non-durables again fell into negative territory (-1.7%) in July, after a
positive performance in previous month. Above-normal monsoon, which could improve rural demand, along with the
lagged impact of interest rate reductions, salary revisions and easier monetary conditions are expected to support
demand in future and boost industrial activity. We, therefore, expect industrial GDP growth to increase to 7.6% in
fiscal 2017 from 7.4% in fiscal 2016.
Retail inflation edges down, on lower food inflation especially in vegetables

CPI inflation fell to 5% in August, led by a drop in food inflation, especially in meat and fish, vegetables,
oil and fats. Food inflation dropped to 5.9% from 8.4% in July. Protein inflation also fell to 12.6%, as inflation
in meat and fish and pulses reduced in August. That said, inflation in cereals, egg, fruits and sugar rose in
August. Inflation in pulses, although moderated in the month, remained high at 22%.

On the positive side, the month-on-month momentum in overall inflation signalled a drop in prices in August
- at -0.1% m-o-m for headline CPI and -0.5% for food CPI.

Core inflation (excluding food, fuel, and petrol and diesel) stood at 5% in August from 5.1% in July, as
inflation edged down slightly in housing, household goods and services, recreation and amusements. That
said, personal care and effects continued to rise in August to 8.3%.

Fuel inflation (including petrol and diesel) rose to 1% in August from 0.9% in July.

Rural inflation fell to 5.9% from 6.7% in July, as did urban inflation to 4.2% from 5.4% in July. Food inflation
fell both in rural and urban areas while core inflation rose in the rural areas.

Inflation outlook

We expect CPI inflation to average at 5% in FY17, assuming a normal monsoon and proactive food supply
management by the government. A normal monsoon will soften food inflation and offset the upside risk to
overall inflation from higher crude prices and sticky services inflation. In addition, other risks to overall
inflation going ahead could emanate from a 1) closing output gap pushing up core inflation and 2) seventh
pay commission payouts. Also, key monitorables for food inflation are: 1) Monsoon; 2) Global oil and
commodity prices; and, 3) Pulses and oilseed inflation.

As expected favourable monsoons have started pushing down food prices - reflected in this months'
readings. Going ahead, ample rains are expected to bring down food inflation further as food supply
increases and the government continues to take steps to ease out supply constraints and improve efficiency
through reforms.

The recent GST bill, passed in the Rajya Sabha, is one such example which will bring down inflation in the
medium run. That said, in the short run, we believe GST implementation might result in increasing inflation
in the service category that currently experiences lower indirect tax rate. The impact will only be felt after
GST is implemented.
Turning to monsoons, latest IMD data shows rainfall so far is -5% of LPA (September 11). Rainfall is
deficient only in the east and northeast and south peninsula region. Out of the 36 sub-divisions, 86% of the
total area of the country has received excess\normal rainfall. Bountiful rainfall has also helped replenish
reservoir levels from the lows seen in the beginning of the fiscal.

Despite a slow start to the monsoon season and a weak sowing start, 97% of the normal area under Kharif
crops has been sown as on September 9. This year, area coverage so far is higher by 44 lakh hectare
than normal as on date with area under rice, maize, coarse cereals, pulses and oilseeds higher than last
year. The most increase is recorded in pulses where sown area is 35.1 lakh hectare higher than last year,
due to higher coverage in Tur, Urad and Moong.

Crude prices have risen by over 30% since April. However, we expect oil prices to remain contained at $4045/barrel in 2016. That said, the benefit to inflation from the lower oil prices will decline this fiscal.

IIP Growth: Contraction in manufacturing pushes IIP back in the negative zone

After rising in the previous two months, inducing optimism about industrial recovery, the index of industrial
production (IIP) again fell back in the negative zone. In July, IIP declined by 2.4% on-year, a sharp reversal
from Junes 2.0%. The weakness was seen across the board. While mining (0.8% growth) and electricity
(1.6% growth) hardly grew, manufacturing sector - the mainstay of IIP with ~75% weightage registered a
growth of -2.4%. Manufacturing sector had grown marginally positively in each of the previous two months.
Twelve of the twenty-two industry groups in the manufacturing sector grew negatively in July from the same
month last year.

Within the manufacturing space, while growth in the consumer oriented sectors stagnated, it fell by 5.4% in
investment oriented sectors in July. It is the biggest pace of decline in the investment oriented sectors in
last six months and was led by electrical machinery and apparatus (-59.2% growth), fabricated metal
products (-3.4% growth) and other non-metallic mineral products (-0.2% growth). On the other hand, in the
consumer oriented sector, the product categories that fared poorly were food and beverages (-0.8% growth),
furniture (-2.5% growth), wearing apparel etc. (-16.2% growth) among others.

According to use-based classification, the fall in the growth of capital goods category intensified, reaching a
record low of -29.6% in July. Growth in consumer goods too slowed down, but remained positive at 1.3%.
Within consumer goods category, while durable goods growth displayed continued improvement (5.9%
growth in July), growth in non-durables again fell into negative territory (-1.7%) in July, after a positive
performance in previous month.

Figures: CPI and IIP

Figure 1: Headline CPI drops in August

Figure 2: Rural and urban inflation edge down

Source: MOSPI, CEIC, CRISIL Research

Figure 3: Fall in food inflation pushes down CPI

CPI (%y-o-y)
Weight

Jan-16

Feb-16

Mar-16

Apr-16

May-16

Jun-16

Jul-16

Aug-16

FY15

FY16

100

5.7

5.3

4.8

5.5

5.8

5.8

6.1

5.0

6.0

4.9

Food CPI

39

6.8

5.4

5.2

6.4

7.5

7.8

8.4

5.9

6.4

4.9

- Cereals & Products

10

2.2

2.2

2.4

2.5

2.6

3.1

3.9

4.1

5.2

1.8

- Pulses & Products

43.3

38.5

34.2

34.2

31.6

26.9

27.5

22.0

7.9

31.7

- Vegetable

6.4

0.7

0.5

5.0

10.8

14.8

14.0

1.0

4.8

1.7

Headline CPI

- Milk & Milk Products

3.9

3.7

3.3

3.4

3.5

3.4

4.1

4.4

10.4

5.2

Protein Inflation

20.6

18.5

17.4

17.7

17.3

14.3

14.8

12.5

6.7

15.1

Fuel & Light

5.3

4.6

3.5

3.0

2.9

2.9

2.7

2.5

4.2

5.3

Transport and
communication excl.
Petrol & Diesel

3.1

3.2

3.1

2.9

3.0

3.2

3.3

2.9

2.5

3.3

Core CPI

52

5.2

5.4

5.1

5.3

5.2

5.0

5.1

5.0

5.9

5.4

- Housing

10

5.2

5.3

5.3

5.4

5.4

5.5

5.4

5.3

7.0

4.9

- Education

5.5

5.8

5.7

5.5

5.8

5.4

5.1

5.2

7.2

6.3

- Personal care & effects

3.4

4.9

5.7

5.7

6.1

5.9

7.3

8.3

3.5

3.7

4-6%

6-8%

8-10%

>10%

Below 4%

Note: Food CPI excludes paan, tobacco, prepared meals and beverages. Core CPI excludes food CPI, fuel and light, and petrol and diesel.
Source: CEIC, Central Statistical Office, CRISIL Research

Figure 4: IIP Performers and laggards

IIP Overall

Manufacturing

Mining & Quarrying

Electricity

Consumer oriented

20.0

Industrial and investment oriented

20.0

15.0

15.0

10.0
5.0

10.0

0.0
5.0
-5.0
0.0

Jul-16

May-16

Mar-16

Jan-16

Nov-15

Sep-15

Jul-15

May-15

Mar-15

Jan-15

Nov-14

Jul-14

Jul-16

May-16

Mar-16

Jan-16

Nov-15

Sep-15

Jul-15

May-15

Mar-15

Jan-15

Nov-14

-20.0

Sep-14

-10.0

Jul-14

-15.0

Sep-14

-10.0

-5.0

Source: CSO, CRISIL Research, Note: All values in % y-o-y

Figure 5: What the latest trend says about sectoral growth

% y-o-y

Weight
%

Dec15

Jan-16

Feb16

Mar16

Apr16

May16

Jun16

Jul16

Q1
FY16

Q1
FY17

General

100

-0.9

-1.6

1.9

0.3

-1.3

1.1

2.0

-2.4

3.3

0.6

Mining

14

2.8

1.5

5.0

0.3

0.7

1.4

5.3

0.8

0.4

2.4

Manufacturing

76

-1.9

-2.9

0.6

-1.0

-3.6

0.6

0.7

-3.4

3.7

-0.8

Electricity

10

3.2

6.6

9.6

11.8

14.6

4.7

8.3

1.6

2.2

9.2

Use-based classification
Basic

46

0.7

1.9

5.4

4.4

4.8

3.8

5.8

2.0

4.6

4.8

Intermediates

16

1.5

2.8

4.9

4.2

2.3

3.9

5.7

3.4

1.6

3.8

Capital goods

-18.6

-21.6

-9.3

-15.3

-25.3

-12.3

-16.3

-29.6

2.2

-16.7

Consumer
Goods

30

3.2

-0.1

0.6

0.6

-2.0

1.0

2.7

1.3

2.6

-0.2

-Durables

16.6

5.6

10.4

10.1

11.8

6.0

5.6

5.9

4.5

10.7

21

-2.7

-3.2

-4.9

-4.9

-11.0

-2.3

0.9

-1.7

1.7

-6.9

-Non durables
Contraction

Growth slowing

Growth
rising

Source: CSO, CRISIL Research, Note: All values in % y-o-y

Analytical Contacts:
Dharmakirti Joshi
Chief Economist, CRISIL Ltd.
dharmakirti.joshi@crisil.com

Adhish Verma
Economist, CRISIL Ltd.
adhish.verma@crisil.com

Sakshi Gupta
Economist, CRISIL Ltd.
sakshi.gupta@crisil.com

Media Contacts:
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Media Relations
CRISIL Limited
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shamik.paul@crisil.com

Khushboo Bhadani
Media Relations
CRISIL Limited
D: +91 22 3342 1812
M: +91 72081 85374
B: +91 22 3342 3000
khushboo.bhadani@crisil.com

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