In the months to come, high inflation in food articles such as fruits, milk & milk products will keep retail inflation sticky around the current level. Preliminary reports suggest that unseasonal rains along with hailstorms and frost have adversely impacted the Rabi crop during early March and thus may have an impact on prices. In addition, an enhanced possibility of an El Ni in 2014 could push up CPI inflation with the weight of agriculture-related articles accounting for 50% of the CPI. However, on the upside, inflation is likely to be capped at 8.5% as the lagged impact of previous rate hikes seeps through. Also falling inflation expectations, a negative output gap and continued weakness in domestic demand will keep inflation at bay.
Balancing these risks, we expect headline inflation to hover between 8.0-8.5%. With the RBI recently re-emhapsing its intent to lower inflation to 8% by January 2015 and to 6% by January 2016, we expect the RBI to keep rates on hold for now - standing in a wait and watch mode.
A continued weakness in domestic demand pressures should however, limit the upside pressure on retail inflation going forward, The Index of Industrial Production (IIP) fell 1.9% in February after staying almost flat in January. Any hopes of a sustained recovery in industrial production due to high core infrastructure sector output growth in February, were dismayed by persistent weakness in consumption demand.
In fiscal 2015, we expect industrial growth to look up - industrial growth (as reflected in industry GDP, which includes construction) is estimated to go up to 4% from 0.6% in fiscal 2014. However, this would still be less than half the growth rate of 8.5% seen between fiscals 2003 and 2012. Sustained and high growth in industrial production beyond fiscal 2015 will require policy focus on easing input constraints and significant improvement in the investment climate.
Drivers of growth in fiscal 2015 are largely transient in nature; (i) addressing some of the issues facing the mining sector will raise mining output, and (ii) infrastructure output will expand as stalled projects cleared by the Cabinet Committee on Investments hit the ground. Although robust export growth due to better prospects in advanced economies will benefit export-driven industries, their weight in manufacturing is only 28%.
A revival in infrastructure investments, if sustained, will eventually help in turning around the slump in consumption demand - weakness in consumer goods' output closely tracks the slowdown in manufacturing. In February, manufacturing output shrank for the fifth straight month with almost all consumer-oriented industries registering a fall in output.
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CRISIL Research estimates show that, in fiscal 2014, capacity utilisation rates in consumer-oriented industries have fallen considerably. In auto, it fell below 50% whereas in cement and steel capacity utilisation rates fell to 70% from 73% last fiscal and to 82% from 86% last fiscal, respectively.
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