Core weaknesses

The June numbers for the Index of Industrial Production (IIP) indicated a moderate decrease in the growth rate for industry as a whole. This is consistent with the general expectation of an overall slowdown in growth during the year, primarily as a response to the series of interest rate hikes carried out over the last few quarters. However, the aggregate number conceals a number of disparities, which point to the fact that some industrial segments appear to be reacting quite sharply to higher interest rates, while others like wood products and processed foods have been uncharacteristically buoyant during the last quarter, for yet unspecified reasons. Now, further analysis of the disaggregated numbers from the Index for the April-June quarter raise concerns that the impact of monetary policy may be reinforced by weaknesses in the "core" sectors, which collectively represent the performance of the infrastructure and energy sectors.

Of the six industries classified as such""crude oil, petroleum products, coal, electricity, finished steel and cement""four have shown slower growth during the first quarter of this year than during the corresponding quarter of last year. The two that have shown faster growth are electricity (8.3 per cent compared with 5.3 per cent last year) and petroleum products (13.2 per cent compared with 11.9 per cent last year). Crude oil production declined during the quarter, which presumably reflects the state of the existing domestic sources of oil, which are known to be running out. What is more worrying is the sharp deceleration in coal, which fell from 8 per cent in the first quarter of last year to a bare 0.7 per cent this year. This is at odds with the acceleration in electricity generation, since most of the country's power still comes from coal-fired plants (though some of them have begun to rely more than before on imported coal). At another, it may reflect an overall reduction in the demand for energy in the industrial sector, consistent with the pattern observed in the broader index. The worst-case scenario is that this sharp decline is because of constraints on production, which will then impose a constraint on the growth of sectors that are dependent on the availability of domestic coal.

The acceleration in petroleum products has resulted in a significant proportion of the increased production being exported. While there are no domestic shortages as such, this outcome is the result of a large mismatch between domestic refining capacity and the distribution system, compounded by the persistence of administered pricing. The slowdown in finished steel and cement production can be explained with reference to the interest rate scenario. Construction activity appears to be plateauing, as existing supplies cope with a sudden drop in demand.

At this point, it is difficult to distinguish between demand and supply factors driving this pattern. If the former predominate, the numbers reinforce prevalent expectations that higher interest rates will eventually dampen growth. However, if supply factors, which constrain production and delivery, are at work, they will exacerbate the effects of moderating demand to reduce the growth rate, while also putting pressure on inflation. In a situation in which global turbulence will put pressure on policy-makers as far as finding a balance between dealing with inflation and balance of payments pressures is concerned, this will only be an additional irritant. It is best to stay watchful.