India services rally is half-victory: HSBC

Service sector grew for second straight month but inflation is still a lurking threat.

The service sector expanded to 54.2 (PMI) in December from 53.2 in November, which HSBC acknowledges led to beneficial trickle-down effects, including the first employment upswing in six months.

But these came at a cots of even more restrictive price pressures that could stifle much-needed policy easing.

Here's more from HSBC:

The momentum in the Indian service sector strengthened for the second successive month in December, with both business activity and new business accelerating. However, price pressures rose sharply along with the new found vigor in growth. This means, it is still too early for the RBI to replace inflation with growth as the main policy concern.

Facts
According to HSBC's India PMI, service sector activity accelerated to 54.2 in December (vs. 53.2 in November), led by 'Hotels & Restaurants' and 'Financial Intermediation'. New business also rose at a faster clip (55.7 vs. 52.3 in November), and the improvement in activity gave a little boost to businesses sentiments (64.4 vs. 63.6 in November).

Due to the bounce-back in both manufacturing and services, the composite index covering the two sectors improved further to 54.7 from 52.3 in the previous month.

Backlogs of work rose, but only slightly (50.4 vs. 50.0 in November). Some panelists reported that a rise in new business and/or delayed payments from clients was reason for the accumulation of unfinished work.

The increase in activity led to an expansion in employment (50.6 vs. 49.8 in November) for the first time in six months. This likely also helped contain the rise in backlogs of work.

However, the increased pace of activity kept inflation pressures firmly in place. Input costs rose even faster (59.1 vs. 57.6 in November) as did prices charged (57.3 vs. 56.0 in November). Moreover, the price increases continue to be north of the historical average.

Implications
The services sector is picking up speed, with the re-acceleration in business continuing for the second consecutive month. This also highlights the services sectors resilience in the face of tighter monetary conditions and an uncertain global economic backdrop.

Nevertheless, the pace of growth still remains below its historical average. Moreover, there is no denying that tight monetary policy, domestic policy paralysis, and adverse external spill overs will constrain growth in the months ahead.

That being said, the domestically oriented segments will help hold up the flag. The structural underpinnings for growth in the sector (demographics, urbanization, rising incomes, etc.) will also provide for continued resilience.

However, the inflation readings are less encouraging, with prices continuing to rise at a faster-than-average pace. This boils down to the late start to the tightening cycle, lagged pass-through of rising costs, labor market tightness, and the lack of structural reform progress.

For the RBI, the latest manufacturing and services PMI numbers suggests that it is premature to replace inflation with growth as the dominant policy concern. A rate cut is, therefore, not just around the corner, but will have to await a sustained decline in core and not just headline inflation. This will take a while to materialize.

Bottom line: Services sector activity continued to pick up. Unfortunately, price pressures perked up as well, leaving the RBI with no room to ease policy rates in the near term.