India’s inflation may have jumped to 9.8% in September

Industrial production could slow to 5% YoY hurt by high interest rates and an unhelpful global backdrop. Core production, a sub-index of the production index, has already painted a weak picture for the month with core production down by 2.5% MoM and on-year growth of just 3.6%. Vehicle sales are very weak with sales down 10% in August from levels in January. Taken together with the ominous signs in manufacturing and services PMI which printed 50.5 and 49.5 in September,
the Jul-Sep quarter has shaped to be much weaker than earlier expectations.

It would be impressive enough for output to normalize in the Oct-Dec amidst worries of another global meltdown, and even such would imply GDP growth of about 7% in 2011/12. Thus, we lower our GDP forecast for 2011/12 to 7.2% from 7.5% earlier, which continues to keep us in the low end of consensus forecasts.

Despite the weakening growth trend, price pressures are on the rise and the economy ironically has to bear the burden of higher retail fuel prices. Diesel and petrol prices were raised in late-June, electricity prices were raised in August and petrol prices were raised again in September. As such, headline inflation is expected to rise to 9.8% YoY in September even though manufacturing WPI, a proxy for core, has moderated.

WPI headline will ease towards 7% by March, if not by December, led by basis effects as well as moderation in core inflation. But inflation may prove sticky at 7%, which is much higher than central bank comfort level of 5%, barring fears of a global meltdown playing out. This means the RBI can hardly let its guard down on inflation. Yet, it would be difficult for the policymaker to hike rates amidst signs of growth coming in much below its expectations (of around 8%) and harder still do so when it meets later this month, given global financial market jitters.

We thus take out a 25bp rate hike we had pencilled in for the Oct-Dec quarter and expect policy repo rate to stay at 8.25% over the next year.