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Inflation in RBI’s range, IIP slips into contraction

January 13, 2021 05:12 AM


Inflation in RBI’s range, IIP slips into contraction
The data indicate that the main thrust of the budget will be fiscal stimulus to revive the economy, say experts

Roshan Kishore

New Delhi : Factory output dipped in November, and retail inflation eased in December, setting the context for the coming Union budget on February 1 as well as the meeting of the central bank’s Monetary Policy Committee (MPC) shortly after. Experts believe the data reiterate that the main thrust of the budget be fiscal stimulus to revive an economy that will likely contract by 7.7% this year, and also create space for the MPC to cut rates further.

According to data released by the National Statistical Office (NSO) on Tuesday, retail inflation, as measured by the Consumer Price Index (CPI), fell sharply to 4.6% in December 2020, 2.3 percentage points lower than the November value of 6.9%, and the Index of Industrial Production contracted by 1.9% in November.

Headline inflation has come below the upper limit of RBI’s tolerance range of 6% for the first time since March 2020. However, the Index of Industrial Production (IIP) has re-entered the contraction zone, raising questions on the resilience of the ongoing sequential recovery in the economy.

With inflation trends largely being driven by a sharp fall in vegetable prices, which will adversely affect farm incomes and hence rural demand, and IIP trends following the cue of contraction in core sector industries and moderation in Purchasing Managers’ Indices, experts underline the importance of fiscal stimulus in the forthcoming budget.

While most analysts expected a moderation in the CPI in December—a Reuters poll of economists had forecast 5.3%— the provisional numbers are much lower. To be sure, the entire fall in the headline inflation number is because of a deceleration in food prices and a sharp fall in vegetable prices. Food inflation, which has a weight of 39% in the overall CPI basket, fell from 9.5% in November 2020 to just 3.4% in December. While prices have decelerated for many important food sub-groups such as cereals and cereal products, eggs, meat and fish, milk and milk products and pulses, they fell sharply for vegetables. Vegetable price inflation, which was 15.5% in November 2020, fell sharply to contract by 10.4% in December 2020.

Non-food inflation has actually increased marginally from 5.2% in November 2020 to 5.4% in December. With a bird-flu scare leading to a crash in poultry prices, chicken, eggs and meat category, which saw annual price growth of 15.3% in December, could also experience a sharp fall in January numbers. “A crash in vegetable prices means a big shock to farm incomes in an already precarious situation”, said Himanshu, associate professor of economics at Jawaharlal Nehru University. “With the non-farm economy and jobs already in a difficult spot, this is really bad news for the economy because even rural demand will come under strain.”

IIP in November 2020 re-entered contraction zone with a year-on-year decline of 1.9% after showing promise in September ( growth of 0.5%) and October (growth 4.2%). The contraction in IIP was broad-based. Both mining and manufacturing components registered a contraction , with electricity being the only sector showing growth. Even in electricity, annual growth fell sharply from 11.3% in October to just 3.5% in November. By usage categories, primary goods, capital goods, intermediate goods and consumer goods contracted in November, with infrastructure being the only sub-sector growing, by 0.7% (against 9.9% in October). While the magnitude of IIP contraction has not been expected, the trend is in keeping with other high-frequency indicators.

The index of eight core sector industries, which was witnessing a moderation in contraction until September 2020, started losing momentum once again from October. The contraction rates were 0.2% in September, 0.9% in October and 2.6% in November. Purchasing Managers Index (PMI) for manufacturing, although it has been above the threshold level of 50—a value above 50 signifies expansion in economic activity over the previous month—since August 2020, also lost momentum in November. PMI manufacturing was valued at 58.9 in October, but fell to 56.3 in November and increased marginally to 56.4 in December. Composite PMI, thanks to a fall in PMI services, fell from 58 in October 2020 to 56.3 in November and 54.9 in December.

“The November (IIP) data once again shows that the uptick witnessed in the month of September and October was due to a combination of festive and pent-up demand and the recovery is still shallow and fragile”, said Sunil Kumar Sinha, principal economist, India Ratings & Research, in a note. “In view of growth concerns, India Ratings expects RBI to continue its accommodative policy stance and maintain status quo on policy rate in the forthcoming monetary policy review while keeping a close eye on the forthcoming Union budget to ascertain government’s fiscal stance”, the note added.

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