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Growth data continued to be fairly healthy. IIP for July remained fairly strong at 6.6% y-y, buoyed by healthy growth in manufacturing, consumer goods (both durables and non-durables) and electricity. Infrastructure index growth was also healthy with important sectors like steel and cement showing healthy growth.
India's Manufacturing PMI increased to 52.2 in September (from 51.7 in August) taking the expansion to 14 months. Rise in PMI is reflective of strengthening demand especially from foreign clients, which helped to drive export growth up to its highest level since the turn of the year. The employment index also increased. Services PMI declined for the second month to 50.9, taking composite PMI to 51.60. Demand (new orders) has slowed for the services sector even as input prices continued to rise. Broad sector data showed that underlying growth in activity and new work remained strongest in Information & Communication. In contrast, there were falls seen in the finance & insurance and business services categories.
Freight traffic remained healthy in railways, airport and cargo. Airport passenger traffic growth also remained strong in mid-teens. Growth in steel consumption picked up further. However, there was some moderation in fuel consumption and auto sales. Credit growth also continues to grow decently, but is being largely driven by services and personal loans and industrial credit growth continue to remain quite low. Bank credit to NBFC sector is growing strongly, and it will be important to note whether this strong growth continues going ahead given the recent events in NBFC space.
Forecast for Kharif output of this year is again positive following record output of last year and large MSP hike for Kharif output augurs well for rural demand. RBI survey of consumer confidence, industrial outlook and capacity utilization remains fairly healthy. The key risk to growth in coming quarter stems from the likely impact of NBFC slowdown on growth and global demand. (Source: CEIC)
CPI inflation once again surprised positively with August reading coming at 3.69% lower than general expectation of analysts and much below the forecast by RBI. Food inflation has persistently surprised on the downside to such an extent that it forced RBI to revise downwards its estimate for inflation in the recent policy meeting. The structural aspect of food inflation being lower as we have continuously highlighted is still playing out.
While the Kharif MSP was high, the recently announced rabi MSP was more in line with recent trends which gives credence to the hypothesis that the MSP rise was mostly a one-off thing. Core inflation reading was neutral and in line with our estimates. However the spike in USDINR and crude in last month or so is bound to have at least one-time negative impact on inflation. The sustainability of such an inflationary impact would however depend on the state of the economy and its ability to withstand the recent headwinds on growth. (Source: RBI, MOSPI)
India external account continued to show pressure with 1QFY19 BoP showing a deficit of 11.3bn USD, largest since December 2011. Deficit is both due to lower capital account surplus and higher current account deficit. Decline in capital account surplus is owing to outflows by FII and short term trade credit. Banking capital witnessed healthy inflows partially due to NRI deposits. Increase in CAD is due to higher oil deficit and gold deficit. However, we expect non-oil, non-gold CAD to also increase in upcoming quarters. Recent trade deficit data reflects possibility of further increase in CAD towards 3% GDP or even more. What is especially concerning for current account is the steady decline in non-oil, non-gold current account surplus since mid-2014. One can argue that this reflects fundamental deterioration in India’s competitiveness which can at least partially be corrected by weak INR.
INR broke to new highs amidst broad based EM selling, FII outflows, rising trade deficit and reduced intervention by RBI. Even while reiterating the policy to not target any particular level of exchange rate, policy makers introduced many steps to reduce imports and boost capital inflows. (Source: CEIC)
RBI MPC surprised the markets in a 5-1 status quo policy, while clearly signalling that inflation remain the anchor of monetary policy. However, it changed the monetary policy stance to withdrawal of accommodation by a 5-1 vote. Given the pressure on INR amidst global liquidity tightening, there was a view in the market that RBI will tighten the monetary policy to defend INR. However, RBI clearly articulated that the legal mandate of monetary policy is to manage inflation and interest rates will not be used to defend currency, but only to manage the inflationary consequence of depreciation. The global composite PMI slipped further for the third consecutive month to 52.8 in September and industrial growth also declined. However, world trade data picked up and EM bond and equity funds witnessed inflows. While EM equities came under pressure, there was some rebound in EM currencies and bonds.
US Federal Reserve delivered the expected 25bps hike in September. US economic data continues to be strong and Atlanta Fed GDP now-cast is tracking 4%. US employment and inflation data remained fairly healthy and corporate profitability and sentiments fairly strong. US yields broke above previous resistance and are currently trading at 3.23%. Crude also broke above 80, with concerns about supply tightness given Iran sanctions and limited spare capacity. Higher crude and US yields are important risks to Indian markets.
Sell-off continued in INR during the month and it has become the overriding factor for the markets to track and react to. The recent monetary policy has tried to buck this trend by focusing more on factors like inflation. It is however more likely that market will continue to focus on currency and global commodity prices. Keeping in mind these factors we maintain our cautious stance in our portfolios. Our strategy of overweight G-Sec in non-accrual portfolios has played out so far as the spreads have widened across for corporate bonds. The global and local uncertainties have only increased during the month. We thus look to maintain a portfolio which is flexible enough to react to market developments and also actively positioned to take advantage of any opportunity across the curve.
RBI: Reserve Bank of India; CAD: Current Account Deficit; EM: Emerging Markets; IIP: Index of Industrial Production; PMI: Purchasing Managers’ Index’; MPC: Monetary Policy Committee
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