March 2015

CRISIL Economy First Cut

Inflation inches up, IIP slows
Overview: In February CPI inflation rose to 5.4% from 5.2% in January, driven by higher food inflation (+60 bps) while core
inflation edged down for the seventh consecutive month. Despite higher food inflation, headline inflation remains in the
comfortable zone. Assuming inflation remains the same in March, headline inflation for 2014-15 will stand at 6% - much lower
than 9.5% in 2013-14.
However, going ahead certain risks have emerged. Untimely rains in recent days have adversely impacted Rabi crops in the
north and central India. As a result, inflation might inch higher or remain close to current levels in the coming months. In
addition, increase in freight charges and petrol and diesel prices might reduce the benefit from lower transport and
communication inflation.
For 2015-16, we expect inflation to average at 5.8% supported by lower oil prices, normal monsoons, pro-active steps by the
government, and better monetary and fiscal coordination. In addition, the recent budget is non-inflationary as it focuses on
boosting supply and capacity rather than fuelling consumption. Given our outlook on inflation, we expect RBI to reduce the
repo rate by 50bps in the next fiscal and it is likely that these reductions will be frontloaded.

In January, industrial production grew by 2.6% compared to an upwardly revised 3.2% in December. Sectors which dragged
down growth were telephone instruments (including mobile phone and accessories), mineral index, steel structures, tractors
and ship building and repairs. This month, the silver lining came from capital goods, which posted growth of 12.8% - the third
consecutive month of strong uptick. However, the January reading of overall IIP data fails to suggest that a sharp uptick in
industrial growth is in the making. Nevertheless, for 2014-15 we expect industry (including construction) to grow at 5.9% as
per the new GDP series. Going forward, in 2015-16 we expect growth at 6.2% led by; (i) an improvement in private
consumption demand as it benefits from an increase in discretionary spending, as food and fuel inflation decline, (ii) faster
implementation of stalled infrastructure projects as the investment climate improves, and (iii) a pick-up in mining activity.

Inflation in the month

CPI inflation rose to 5.4% y-o-y from 5.2% in January. Food inflation rose to 6.8% from 6.2% in the previous month,
while core inflation fell by 0.2 percentage points to 4.4% in February.

Food inflation was pushed up by higher inflation in vegetables (13%) and pulses (10.6%). Albeit, the rise in
vegetable inflation came on the back of a weak statistical base from last year as the month on month momentum in
vegetable inflation actually declined. Inflation in categories such as fruits, milk and milk products and spices
remained above 8% in the month. On the other hand, inflation in cereals and products fell to 2.9% - in large part due
to the fact that it includes public distribution prices as per the new series.

Core inflation fell for the seventh consecutive month to 4.4% from 4.6% in January, driven by fall in prices of

11

CRISIL Economy First Cut

transport and communication (-2.2%). However, excluding the impact of transport and communication (16% weight in
core), core inflation stood at 5.6% - only slightly lower than 5.7% in the previous month. Therefore, in the coming
months, a rise in freight charges as well as any upside to petrol and diesel prices could reverse the recent decline in
core inflation.

For fuel and light, inflation rose to 4.7% from 3.8% in the previous month.

Untimely rains in recent days has adversely impacted Rabi crops. Madhya Pradesh, Haryana and Rajasthan have
received heavy rainfall affecting crops such as wheat, chana, mustard, and barley. While ample stocks of wheat can
be deployed to curb wheat inflation, prices of chana, mustard and barley could rise. As a result, overall inflation might
witness an upward pressure in the coming months. In the new series, cereals and pulses products account for 12.1%
of the CPI basket.

Figure 1: Food inflation drives headline CPI up in February

CPI (%y-o-y)
Headline CPI
Food CPI
Cereals & Products
Vegetable
Milk & Milk products
Fuel & Light
Core CPI
Housing
Clothing, bedding & footwear
Transport and communication

Weight
100
39
10
6
7
7
54
10
7
9

Below 4%

4-6%

May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15
8.3
6.8
7.4
7.0
5.6
4.6
3.3
4.3
5.2
5.4
8.9
7.2
8.9
8.7
6.2
3.8
1.2
3.9
6.2
6.8
7.8
6.8
6.6
6.1
5.6
5.2
4.4
3.2
3.2
2.9
10.7
4.3
12.6
10.8
0.7
-8.4
-16.8
-3.4
8.8
13.0
10.9
10.9
11.1
11.3
11.0
10.8
10.4
9.8
9.6
9.2
4.7
4.5
4.3
3.9
3.4
3.4
3.5
3.4
3.8
4.7
8.3
6.7
6.7
6.2
5.5
5.4
4.9
4.7
4.6
4.4
13.7
6.8
6.6
6.1
5.8
5.6
5.4
5.2
5.1
5.0
8.4
8.2
8.3
8.0
7.3
7.3
6.9
6.3
6.2
6.4
7.0
6.4
5.6
4.4
1.9
2.1
1.2
0.3
-1.2
-2.2
6-8%

8-10% >10%

Source: CEIC, Central Statistical Office, CRISIL Research

A non-inflationary budget and greater monetary and fiscal coordination to keep a tap on inflation
The verdict on the 2015-16 budget is that it is non-inflationary. The budget focuses on investment and hence boosting supply
and capacity rather than consumption. In addition, the commitment towards high-quality fiscal consolidation with a lower target
of 3.9% of GDP for 2015-16 from 4.1% this fiscal, is in accordance with the expectations of the RBI.
The most important of the recent steps announced in the budget has been the adoption of a new monetary policy framework
between the government and the RBI. As per this agreement the RBI will target inflation at 6% by January 2016 and at 4%
with a band of +/-2% for subsequent years (in line with the recommendation of the Urjit Patel Committee). The framework also
entails that the RBI will, every 6 months, provide details on the sources of inflation and its forecasts for 6 to 18 months. This
will result in greater transparency and predictability on central bank action. A positive spill over from this would be greater
predictability on wage growth, government yields and purchase decisions by consumers.
However, while the 6% target we think is achievable, squeezing inflation to 4% sustainably is a tall order. This will require the
government to take concrete measures to improve agricultural productivity and curb wastage.

Inflation in the year ahead

We expect inflation to average at 5.8% in 2015-16 as compared to an estimated 6.5% for 2014-15. The dampeners to
inflation next fiscal will be 1) lower crude oil prices - we expect crude oil prices to decline to $60-65/barrel (Brent) in FY16 from
$85-90/barrel in FY15. This is the first round effect. Additionally, second round effects through lower production and

2 2

transportations costs will also play out. 2) Normal monsoons in 2015-16. Factors that will keep inflation low in 2015-16 and
beyond include 1) proactive steps by the government such as lower MSP increases and better utilization of food grain stocks
2) improved monetary and fiscal coordination with the adoption of the new monetary policy framework and governments
commitment to reduce the fiscal deficit in the recent budget. In addition, clarity on inflation targets will also help anchor
inflation expectations.
Figure 2: Headline inflation remains below 6%

Note: CPI old series up to Dec12, CPI new series beyond that. RBI
target of 4% is for beyond 2015-16

Source: CEIC, CSO, CRISIL Research

IIP: Growth slows in January; no sign of sustained pick-up

In January, industrial production grew by 2.6% compared to 3.2% in December. December IIP growth was significantly revised
up from the previous estimate of 1.7%. The slowdown in January was led by second consecutive month of fall in mining output
and lower growth in electricity sector. The output in these two sectors fell 0.2% in January compared to 1.2% growth in
December. Manufacturing sector growth too slowed to 3.3%, from an upward revised 3.8% in December.

The items that contributed to slower growth were telephone instruments (including mobile phone and accessories),
mineral index, steel structures, tractors and ship building and repairs.

Specifically, core sector growth fell to 1.8% from 2.4% in December, whereas growth in the non-core IIP index slowed to
2.9% from 3.7%. Going forward, core sector will have to buckle up first to support overall growth. For instance,
improvement in coal supply linkages will be crucial to ensure uninterrupted power supply to industry. Similarly, other
infrastructure related hurdles will have to be ease to improve the overall ease of doing business in the economy. The
budget took a step in this direction by increasing the governments capex mainly to fund infrastructure investment in
roads, railways, urban development and irrigation. Doing so, can (i) crowd in private investment in infrastructure over
time, (ii) create large spillover effects on output and employment and (iii) overtime create enabling conditions for the
manufacturing sector by improving the countrys transport infrastructure.

In January, manufacturing sector growth was slower during the month, led by continued sharp fall in output of radio, TV,
communication equipment, Medical, precision & optical instruments, watches and clocks segments, and Office,
accounting & computing machinery segments. Out of 22 industry groups 8 sectors posted negative growth during the

3
3

CRISIL Economy First Cut

month.
o Led by a sharp fall in consumer durables and some decline in consumer non-durables output, growth in the
consumer goods sector again posted a contraction in output after turning mildly positive last month
o Capital goods sector showed a surprise, with output expanding 12.8% in January. This is the third month of strong
output growth in the sector.
For April to January fiscal 2015, IIP growth stood at 2.5%, which although is higher than 0.1% growth in the previous fiscal,
reflects weakness in industrial activity. Moreover, most of the pick-up in the year so far was being led by core sector - higher
electricity output (9.5%) which has now begun to slow and an uptick in mining activity, which too has lost momentum. Going
forward, CRISIL Research expects the mining sector to show some gradual pick-up in fiscal 2016. In the coal sector, for
instance, we expect production to grow at a healthy pace driven by faster pace of regulatory clearances and improving
evacuation infrastructure. Moreover, even captive coal blocks bid out during the auction, are expected to witness strong
growth, given the upfront cost incurred by the successful bidder as well as penalties for non-performance.

Figure 3: IIP stuck in low growth zone

Figure 4: Core IIP supported growth this year

Note: *includes coal, crude oil, natural gas, petroleum refinery, and fertilizer, steel, cement and electricity sectors
Source: CSO, CRISIL Research

4 4

Figure 5: Sectoral Growth (%, y-o-y)

AprWeight
14
General

May14

Jun14

Jul14

Aug-14

Sep-14

Oct-14

Nov-14

Dec-14

Jan-15

1,000.00

3.8

5.6

4.4

0.9

0.5

2.6

-2.7

3.9

3.2

2.6

Mining

141.6

1.7

2.5

4.8

0.1

1.2

0.1

4.5

3.9

-2.1

-2.8

Manufacturing

755.3

3.0

5.9

2.9

-0.3

-1.1

2.7

-5.6

3.1

3.8

3.3

Electricity

103.2

11.9

6.7

15.7

11.7

12.9

3.9

13.7

10.0

4.8

2.7

Use-based classification
Basic

355.7

8.6

7.5

10.2

7.0

9.0

5.0

9.7

7.1

5.7

4.5

92.6

13.4

4.2

23.3

-3.0

-10.0

12.3

-3.2

6.6

5.3

12.8

Intermediates

265.1

3.0

3.5

2.6

2.9

-0.1

2.0

-3.4

4.5

1.0

-0.8

Consumer
Goods

286.6

-4.8

4.6

-8.8

-5.9

-6.2

-4.0

-18.2

-2.1

0.3

-1.9

-Durables

53.7

-7.7

3.6

-23.3

-20.4

-15.0

-11.1

-35.2

-14.5

-8.9

-5.3

-Non durables

233

-2.7

5.2

1.9

5.2

0.4

1.3

-3.6

6.2

5.1

-0.1

Capital

Source: CSO, CRISIL Research

Analytical Contacts:
Dharmakirti Joshi

Dipti Deshpande

Sakshi Gupta

Chief Economist, CRISIL Ltd.

Senior Economist, CRISIL Ltd.

Junior Economist, CRISIL Ltd.

Email: dipti.deshpande@crisil.com

Email: dipti.deshpande@crisil.com

Email: sakshi.gupta@crisil.com

Media Contacts:
Tanuja Abhinandan

Jyoti Parmar

Communications and Brand Management

Communications and Brand Management

Email: tanuja.abhinandan@crisil.com

Email: jyoti.parmar@crisil.com

Phone: +91 22 3342 1818

Phone: +91 22 3342 1835

5
5

CRISIL Economy First Cut

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