The double-digit growth in the index of industrial production (IIP) in August is indeed the strongest performance in the last two years. With this, the industrial sector registered an average growth of 8.6% for the last three months. However, of late it has been widely discussed that year-on-year growth numbers do not give a realistic picture. Also, the monthly frequency needs to be adjusted for seasonality and for comparison. Accordingly, the estimated seasonally adjusted (Census X-12 variant) figures show that the industry is growing at 8.1% (average) in the last three months (y-o-y), thus indicating a clear recovery in the domestic industry. But the seasonally adjusted month-on-month figures show the recovery from January 2009 itself, which is obviously quite difficult to agree! For policy making, as the above estimates suggest, the choice of relevant growth estimation procedure is quite pertinent.
Now the issue is whether this turnaround in the industry could be the end of the rough ride that the Indian economy has been going through since the beginning of the global financial crisis. Here, it is necessary to note that the recovery in IIP growth is largely due to domestic factors such as stimulus packages, and to some extent, the low base effect. For the same reasons one may expect continuous high growth for the rest of the financial year with low base, as the average growth for September 2008 to March 2009 is close to 1%. But in the medium term, there are still some downside risks that may result in low growth in the coming months.
There are three significant downside risks that restrain the sustenance of the current high IIP growth. First, as was experienced in the last four years prior to crisis, the high growth was significantly supported by the growing external demand, which resulted in a high exports growth. As it appears till now, the negative growth in exports is expected to continue for the rest of the year since the global economy is yet to show a strong recovery. As the deputy chairman of the Planning Commission felt, this slowdown could even spill over in the next financial year as well, indicating that a full recovery does not seem likely in the near future. Rising inflationary expectations come second. As there is a strong trade-off between growth and inflation, any rise in inflation may reduce the non-agricultural output growth. Our India-LINK forecast show that the WPI inflation could touch 7.5% by the end of 2009-10, which might warrant monetary tightening much earlier, which in turn, might hamper private investments. In other words, the government?s fiscal stimulus packages have indeed started showing positive impacts on domestic demand in the short run. But in the medium run, it has the potential to crowd-out private investments. Thirdly, an expected negative kharif output growth this year might hamper domestic demand for industrial goods in first two quarters of 2010.
Overall, although IIP growth is picking-up in the recent period, it is too early to conclude that the worst is over. The recent recovery only provides leverage to the monetary authority in preponing monetary tightening measures that are necessary to prick the inflationary expectations.
?The writer is professor, NIPFP