Inflation is up & rising Covid cases can upend the patchy recovery; neither govt nor RBI can afford to get it wrong
With exports under pressure, labour-intensive sectors have been doing badly for a long time now.
The wholly unexpected contraction of 1.6% year-on-year (y-o-y) in the factory output for January suggests the recovery isn’t a secular one. The economy is no doubt coming back to life, as seen in a range of high-frequency indicators, but it is doing so in fits and starts. The 9.6% y-o-y fall in capital goods should have been expected; the capex cycle isn’t expected to pick up for a while, and moreover it is a lumpy business, so there is no reason to be too disheartened on that score.
But the 4.2 % y-o-y contraction in the consumer segment, with both durables and staples clocking negative growth, is a bit of a shock, especially since the wedding season was on. This would suggest that the pent-up and festive demand, which boosted sales until December, is now flagging. In the case of two-wheelers, for instance, the sector has reported a year-on-year fall in every month this fiscal except for December. Analysts have attributed the dull sales to the vehicles becoming more expensive and, therefore, unaffordable.
One trend that stands out in all the data is that the recovery in labour-intensive sectors, such as textiles and gems and jewellery, lags that of other sectors. With exports under pressure, labour-intensive sectors have been doing badly for a long time now.
The fading demand impulses may not be the result of just falling or smaller incomes, it could also be the lack of confidence. The continuing accumulation of bank deposits, at a very high rate of 11-12%, indicates that households prefer to save rather than spend.
To be sure, some of this could be temporary given options to travel and consume a host of services is very limited right now. Nonetheless, one would have expected the fairly smart pick-up in residential property sales to catalyse sales of consumer durables.
The loss of tempo in industrial production in January would have been less of a concern had it not been for the sharp surge in Covid-19 infections and the imposition of lockdowns or curfews in some cities. The bigger worry now is the elevated cost of inputs and the rise in inflation despite stable food prices; core inflation for February came in at 6% y-o-y, a 28-month high.
Given the re-bound in the economy and the spike in commodity prices, core inflation might well stay sticky at these levels. Unless food prices trend downwards, RBI’s inflation outlook of 5.2% for H1 2021 could be at risk. Indeed, the central bank is in a spot as it attempts to tackle multiple challenges—controlling the yields, facilitating the government’s large borrowing, ensuring the rupee doesn’t appreciate beyond a point as dollar inflows remain strong and controlling excess liquidity.
For the moment, RBI simply cannot afford to raise the policy rate given how benchmark bond yields have already spiked and are trending around 6.2%; rate changes—repo or perhaps the reverse repo—can be expected towards the end of 2021.
As for liquidity, the central bank probably cannot also exit its accommodative stance for another five to six months. Given how globally central banks remain accommodative, this approach would not be out of sync. For the moment, RBI must bat for growth; else, the economy could lose further momentum hurting the government’s tax collections and its spending plans.