Low inflation and bounce in IIP: RBI got it bang on target

On June 12, 2023, the MOSPI announced the all important CPI inflation data and the index of industrial production (IIP) data. While IIP captures the growth in industrial output, the CPI inflation captures the change in consumer prices. Obviously, the endeavour will be to boost IIP growth while keeping inflation under control. While the CPI inflation is announced each month for the previous month, the IIP is announced with a lag of 1 month. Hence on June 12, 2023, the MOSPI announced the CPI inflation data for May 2023 and the IIP data for April 2023. While these are not strictly comparable, they give a brief idea of where inflation is headed and where growth is  headed. Let us look at the inflation story first.

Inflation comes in lower than expected at 4.25%

Ahead of the inflation number announcement, the Bloomberg consensus estimate had pegged retail inflation at 4.42%. The actual inflation at 4.25% was much lower than that.

Data Source: MOSPI & Ministry of Finance Estimates

The table says it all. The sharp fall in consumer inflation for the month of May 2023 marks a 2 year low. It was driven lower by weak food inflation and a sharp fall in fuel inflation. Core inflation also fell but not enough. A longer term perspective gives a much better picture. Inflation touched a peak of 7.79% in April 2022 and has since come down to 4.25%. but there is one more interesting aspect of the fall in inflation. February 2023 was the last time the RBI hiked repo raters by 25 bps and has maintained status quo after that. Despite that, the consumer inflation has fallen from 6.44% in February to 4.25% in May 2023. Clearly, it is a case of the lag effect of the rate hikes showing up.

What is it that drove the inflation number so firmly lower? Both food and fuel inflation were the key triggers for the sharp fall in headline inflation in the month of May 2023. Consider these numbers. Food inflation fell from 3.84% in April to 2.91% in May 2023. In fact, in September 2022, food inflation had peaked at 8.6% and has since fallen sharply as the Rabi output has started coming into the mandis. The other big factor was fuel inflation. Both fuel inflation and transport inflation used to be in double digits around 5-6 months back. For May 2023, fuel & light inflation is down to just 4.64% while transport inflation has fallen all the way to 1.10%. That can be largely attributed to the sharp fall in crude prices to $73/bbl.

IIP bounces back to 4.2% in April 2023

It was like a double blessing on the macro front. It is not just that inflation fell sharply. Even the index of industrial production (IIP) bounced from 1.1% to 4.2% for the latest month. Interestingly, this bounce was led by manufacturing. First, let us get a macro IIP picture.

Data Source: MOSPI

To be fair, while IIP has bounced from the March lows, it is still lower than the median of the IIP growth rate between November 2022 and February 2023. During this 4 month period, the IIP had a median figure of around 5%, so the IIP is still lower than that level. What is more important is how the various aspects of IIP growth fared in the month.

Broadly, the IIP growth can be broken up into mining, manufacturing, and electricity. Mining growth for April 2023 was lower at 5.1% compared to 6.8% in the month before. Manufacturing grew at a strong clip of 4.9% in April 2023 compared to a tepid 0.5% in March 2023. Finally, Electricity contracted by -1.1% in April 2023; but less compared to -1.6% in March 2023. As is the norm, it is the manufacturing figure that the overall growth gravitates towards since manufacturing has a weightage of 77.6% in the overall IIP basket. In April, it is manufacturing that has shown extremely good and solid traction.

Over to the RBI, and how they were right all along

First a quick background to this debate. Back in April 2023, the RBI surprised the street by announcing a pause in interest rates. The RBI contention was that rates had been hiked by 250 bps between May 2022 and February 2023. While the intent was to control inflation, it had one obvious negative effect. It had raised the borrowing costs for Indian companies. That was evident in their shrinking net margins and their worsening coverage ratios. There was pressure building from the industry associations as the higher rates were hitting Indian corporates hard. It was then that the RBI had decided on the pause.

In retrospect, it was a brave move and could have backfired. Had it resulted in a spike in inflation, then the reactions would have been entirely different. More so, because the move also risked monetary divergence. In fact, after the RBI had paused in April, the Fed has hiked rates twice by 25 bps each as have other central banks. The good news is that inflation actually fell lower and growth also showed green shoots of bouncing back. The first evidence came from FY23 GDP growth at 7.2% coming in better than expected. It was a risky gambit, but in the end it did pay off and the markets are much happier. As for global risks, the best answer has come from the FPIs, which infused $5.3 billion in the month of May alone. The RBI did bell the cat in a tough situation and it paid off.