India’s industrial production disappoints at 3.3% in July

Industrial production grew slower than expected (3.3% y-o-y in July vs. 8.8% in June), mostly due to the volatile capital goods segment and on the back of last year's high base. On the other hand and encouragingly, the consumer goods segment saw an uptick in growth. Abstracting from the volatility, growth is moderating and not collapsing. With inflation pressures not abating, this should keep the RBI in tightening mode and we expect a 25bp rate hike this Friday.

Facts

Growth in factory output in July dipped to 3.3% y-o-y (vs. 8.8% in June), which was much lower than the consensus (6.2%) and our forecast (6.8%). In sequential terms and on a seasonally adjusted basis, industrial production contracted by 1.8% m-o-m (vs. 1.7% in June) and by 6.8% 3m/3m annualized (vs. -4.1% in June).

By industry groups, the index-heavyweight manufacturing saw growth slow to 2.3% y-o-y (vs. 10.3% in June) driven by a decline 'electrical machinery & apparatus' of no less than 46% y-o-y (vs. +89.5% in June). Meanwhile, electricity production (13.1% y-o-y vs. 7.9% in June) and mining (2.8% y-o-y vs. -1.1% in June) grew at a faster clip.

By use, the main driver of the deceleration was capital goods (-15.2% y-o-y vs. +38.2% in June) which is lumpy and, consequently, volatile by nature. Intermediate goods (-1.1% y-o-y vs. 0.6% in June) also weakened, but basic goods (10% y-o-y vs. 7.5% in June) and consumer goods (6.3% y-o-y vs. 2.3% in June) saw faster growth. In the latter's case, output of both durables (8.6% y-o-y vs. 1.5% in June) and non-durables (4.1% y-o-y vs. 3.0% in June) grew faster.

Implications

While this number was much weaker than anticipated, there is no need to panic about growth in India.

The reason why we hold on to this view is that the deceleration in industrial production growth was to a large extent driven by the volatile capital goods segment, which jumped by around 38% y-o-y in June and also faced a high base in July last year when output rose by more than 40% y-o-y.

If you weed out this volatility, growth is actually holding up reasonably well. For example, total industrial output grew on average by 6% in June-July vs. an average of 5.9% in April-May. So, hardly any change in the average rate of growth.

Furthermore, looking beyond the capital goods segment, there were a couple of bright spots in today's numbers. Growth in consumer goods and basic goods improved, which tells us that final demand is still holding up relatively well.

Now, this is not to say that growth is not slowing. It certainly is. But, we are seeing a moderation and not a collapse in growth. This moderation is the natural result of the lagged effects of monetary tightening, the high level of inflation, tight capacity, and now stronger global economic headwinds.

This moderation in growth should be broadly in line with RBI's expectations and the RBI should on balance still consider inflation risks the bigger concern considering the continued upside surprises on that front as per the latest WPI and PMI readings. As such, we expect that the RBI will most likely tighten again later this week, in a calibrated fashion with a 25bp hike in the policy rate.

Bottom line: July IP growth was pulled down by the volatile capital goods segment and a high base last year. Stripping out volatility and looking at other sectors, the picture is one of a moderation in growth rather than a collapse. With inflation pressures not abating, this should keep the RBI in tightening mode this week.