Factory output may clock 9-10% growth each month during the current year despite the disappearance of the low base advantage
Over the past two weeks, the Index of Industrial Production (IIP) data for March followed soon by the Wholesale Price Index inflation numbers for April were announced. Industrial recovery has been strong through last year. But manufacturing inflation, rather than food inflation, has become the Reserve Bank of India's main worry.
The common thread linking the two is inflation. Should there be monetary intervention, say an interest rate hike, to counter inflation without stifling the apparently robust industrial growth. If that is necessary how soon should it take place?
Signs of deceleration
Industrial output measured by the IIP grew by 13.5 per cent in March over the previous year (March 2009). In January and February 2010, it was 16.7 per cent and 15.1 per cent in February. On the face of it, there is a slight deceleration during the first three months of the calendar year (the last quarter of 2009-10). It is likely that the gradual monetary tightening that is taking place and the withdrawal of fiscal stimulus measures are having their impact but one has to wait for some more months before arriving at a definite conclusion.
More certain, however, is the fact that with a 13.1 per cent growth in March, the average increase in industrial output for the whole of 2009-10 has been at a healthy 10.4 per cent. For the last quarter (January-March 2010), industrial output grew by a phenomenal 15.1 per cent. That contrasts with just 2.8 per cent in 2008-09. In 2007-08, the IIP growth was at a respectable 8.5 per cent. Industrial performance in 2008-09 was obviously hit by the global recession while the data for the last year clearly show recovery. With the pace of industrial growth now in evidence, GDP growth in 2009-10 may exceed the 7.2 per cent estimated by the government.
The base effect
Will the recovery be sustained through 2010-11? Sceptics base their arguments on two points. One, the industrial output data, impressive as they are, have to be evaluated in relation ‘to the base effect'. The IIP data and indeed practically all important official data involve a year-on-year comparison. It follows that if the previous year's growth (the base) is a low figure, the current one will look more flattering than what it actually is. Conversely, a high base last year will make the current year's figure look small.
The IIP increased by just 0.3, 0.2 and 1 per cent, respectively, in January, February and March 2009. Obviously, that has made the corresponding figures for January-March 2010 look so impressive. In the coming months, the benefit from the base effect will gradually peter out. Industrial activity picked up, albeit slowly, from April 2009 onwards. According to one view, despite the disappearance of the advantage (from the low base), industrial output may register a healthy 9-10 per cent growth each month during the current year.
Second, inflation and the need to tackle it head on may invite stronger monetary measures and that may choke industrial performance. The WPI inflation for April is 9.59 per cent. Inflation has become more generalised and not confined to food items. The RBI has said manufacturing inflation will determine its policy response. With demand running high, many industries are witnessing capacity constraints and increasing costs. Whether the RBI will intervene — and that too outside the policy dates — will, however, depend on a number of other factors, including the European debt crisis.
Petroleum prices are a big worry. Although they are ruling at around $70 a barrel, there has been intense speculation as to whether the prices will start climbing to three digits. The government, which has clearly provided far less for subsidies in the budget than warranted, has been on the horns of a major dilemma: whether to free the retail prices of petroleum products thereby pushing up inflation or risk adding to the fiscal deficit. However, on further analysis of the March IIP data, it is seen that the recovery is broad-based. Most components — basic goods, intermediates, capital goods and consumer durables — have contributed to the overall good performance. Capital goods and consumer durables have been outstanding performers through 2009-10. While the expectation is that such strong industrial growth will continue, there are some who even question the assumption of a broad-based recovery and doubt investment demand has picked up. The demand for capital goods has come from relatively few sectors. Few infrastructure sectors outside power and telecom are seeing dramatic growth.