India's industrial production growth exceeds market expectations

While this was a positive surprise, says DBS, markets remain depressed viewing the number as too low.

DBS Group Research said:

Industrial production growth (May) bettered market expectations of 1.8% (YoY) and clocked growth of 2.4% (YoY). While this was a positive surprise, markets remain depressed viewing the number as too low.

In sequential terms, industrial production rose by more than 10% (MoM, saar) if downward revisions to previous months are not factored in. After factoring in the revisions, production grew by 25% (MoM, saar) – very solid and a far cry from what the headline YoY print reads. Capital goods production was the key driver with growth of 70% (MoM, saar).

It is sequential growth that signals the ups and downs in a business cycle and the YoY reading, by definition an average of the sequential growth in the preceding twelve months, will naturally lag. Year-on-year growth doesn’t bounce around too much from month to month due to fundamental factors (rather it bounces due to high / low base effects). Thus, industrial production cannot be expected to sharply improve in May or any month for that matter for fundamentals reasons.

Our reading of the production data is that output was weak from April to September / October last year and then improved from November to February. The deterioration in the business environment impinged on capital goods production from March and output slowed in March-Apr as businesses cautiously curtained investment.

The stabilization in the business environment (though issues and uncertainties remain) and the room for payback in capital goods production growth have triggered a recovery in production in May (as we expected) and this trend is set to continue for a few more months. Capital goods output will continue to remain sub-par even so, but this adjustment higher in capital goods will take overall production growth to about 6% (YoY, 3mma) by September and December, far better than the 1% average in Dec-May.

Note though that basis effects are such that June production will likely dip to 0.7% (YoY) first even as the recovery remains intact in sequential terms (leading to more panic about the “persistently weak” data). Note also we don’t expect capital goods production to stage a complete turnaround even assuming improvement in the investment policy environment – businesses (and investors) will remain cautious and wait for signs that any policy reforms are durable and carry depth and breadth.

What is the take-away? Growth is weak this year but not as weak as the current headline YoY reading for industrial production makes it to be. Our calculations suggest production growth of 5% in 2012/13 (Apr-Mar) and GDP growth of 6.2%. This is sub-par and suggests the central bank will be willing to deliver some more rate cuts.

Despite persistent headline inflation (no thanks to higher food prices), the central bank could deliver a 25bps rate cut at the late-July policy meeting and another 25bps cut at the mid-August policy meeting. That means monetary policy remains tight to facilitate correction in external imbalances and to keep wage inflation in check, but delivers a small (100bps) stimulus to the economy this year.