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Where is industrial production headed?news
14 December 2006

For the first time in six months, questions are being raised on the macro-economic fundamentals of the economy, with questions being raised on the robustness of the economy. A CNBC-TV18 shares experts' views with domain-b.

First, the scare on interest rates following the CRR hike and yesterday the industrial growth numbers surprised almost everybody without exception. Abheek Baruah of ABN Amro and Robert Prior-Wandesforde of HSBC Holdings give their perspective to the industrial output numbers that came out yesterday.

Prior-Wandesforde feels that November's industrial production growth may bounce to double digits. According to him, industrial output numbers in November would be the key and that holiday for Diwali was the main cause for the low October numbers. He expects another 50 bps hike in reverse repo rate in H1CY07. He further adds that US slowdown could knock 50 bps off India's GDP growth.

Baruah believes that adjustments due to the Diwali holidays may have caused industrial output numbers to dip. He feels that there is nothing to suggest a dramatic slowdown. He mentions that it is premature to conclude that cap growth is slowing down.

What is your sense after looking at those industrial numbers, do you think it's just a blip, which will get revised or is there genuine reason to be concern?
Baruah: That's pretty much my sense. One can consider looking at it from two perspectives. One is to question the veracity or the accuracy of the data, and if you benchmark it against something like the 'purchase managers index' for manufacturing, clearly there seems to be a disconnect. The purchase manager's index for October shows virtually no signs of any softness.

So I would sort of have some reason to doubt the accuracy of that data. Number two; even if they were to sort of take the accuracy for granted, there are a couple of reasons why this could have happened. One was the fact that in October 2005 you saw a sudden uptake in categories like capital goods and consumer goods and the base effect could itself pull it down. Number two, one must recognise the fact that October was the Diwali month and these are sort of production numbers that we are talking about.

So one possibility is that there could have been some sort of adjustment in inventory in October after a sort of a production built up to the Diwali month. There also could have been a sort of plant closure for a couple of days with dry production down for a bit. So I think there are enough explanations in both senses to explain this dip.

Come in on that- is it looking like a blip? What's more concerning- the numbers that are coming now or if we do not see a bounce back in November?
Wandesforde: I think the key probably is the November data. I would very much agree that the key factor as far as the weakness in October was concerned was the Diwali holiday, which meant there are fewer number of working days in the month. Typically you see a noticeable affect in the Diwali month- industrial production typically falls in that month and it bounces back very strongly in the next month.

I would expect to see exactly the same thing this time as well. In fact I wouldn't be surprised to see industrial production back at a double-digit growth rate in November. So I don't think there is any particularly good fundamental reason to believe that industrial production is slowing. We are still looking at a very robust growth story indeed fueled by extremely low interest rates.

Assuming that there is no revision downward or upwards from the CSO (Central Statistical Organisation) and even if things were to slow down, would they slow down so alarmingly in just a month or do you actually see it as a gradual slowdown?
Baruah: From the sort of whatever other numbers that we track, there seems to be nothing to suggest very dramatic slowdown. In fact I would expect the numbers to improve from November onwards.

Let me again emphasise that the purchase managers' index, which we track, is actually historically proven to be a very close correlate of the IIP. We have the numbers for November and that shows very healthy growth. There are other problems — the problem of input cost and so on — but certainly no problem in top lines or production.

Would you say then that even though there isn't a big hit because of what is happening with external demand, higher local interest rates, consumer spending softening are just getting into a softer phase in terms of industrial growth for 2007?
Baruah: I am not entirely convinced that consumer spending is softening that drastically and I think there is a fair bit of momentum in the system. Of course external demand remains a problem.

We have been far more leveraged on global growth and if the US does moderate, it would have some kind of transmission impact.

But I think you will sort of see that really beginning to show in the numbers both in terms of sort of corporate topline as well as broader macro numbers only in the second half of calendar 2007, and not before that. This is really an aberration and I wouldn't take this as the first sign of a sustain slowdown.

The other big concern in our market is the prospect of interest rates going up quite a bit. What is your own sense of what the Reserve Bank is trying to do and by how much could rates inch up in the system out here?
Wandesforde: I think the first point is that interest rates are very low. If we look at real short-term interest rates, we take the RBI's reverse repo rate and remove from that CPI inflation, which is now running close to 8 per cent, then we get a highly negative real interest rate.

I think that's really what is driving a lot of demand out there. The key issue seems to be whether supply can keep up with demand — I suspect they can't. That's why we are beginning to see signs of excess coming through.

So against that kind of a background, I would be looking for the Reserve Bank to continue to tighten its policy. I suspect there will be still fairly cautious inner approach but I will be looking for say another 50 basis points sort of 0.5 per cent on the reverse repo rate during the first half of next year despite the fact that the US economy will continue to slow from here.

Any concerns on the questions raised about the world trade cycle and whether there is collateral damage for us as a market?
Wandesforde: I think that the world trade cycle is now turning down. I think the US is slowing and other countries around the world are beginning to respond to that. So I suspect that would continue from here and I think India will be impacted by it but certainly won't be impacted as hard as most other Asian countries.

So it certainly shouldn't be in the frontline as far as the impact is concerned. I would anticipate that the US slowdown could knock something like 0.5 per cent of Indian GDP growth, which, in the context of the recent growth rate of 9 per cent plus, is not going to make a huge difference. I think the economy would continue to grow above its long-term trends for the coming months and the coming years.

People in the equity market are now debating since yesterday whether they should go light on sectors like capital goods, two-wheelers and cement in the light of the industrial growth numbers. Would you say it's premature and too hasty to draw conclusions like that?
Baruah: I think it is premature. There could be other problems — input costs are a problem, excessive completions is a problem in some segments like two-wheelers — but that's a separate issue.

In terms of sales momentum or growth momentum, I think it is a little premature. There seems to be enough signs of the consumer boom sustaining, so I would really think it's little premature.

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Where is industrial production headed?