CRISIL First Cut

Loss for inflation, Win for industry

August 2016

Inflation rose for the fourth consecutive month to 6.1% - a 23-month high - in July on the back of rising food inflation
and an unfavourable base effect. While food inflation increased to 8.4% (+60 bps), core inflation remained contained
at 5.1%. Moreover, categories with inflation higher than 6% accounted for only 23% weight, comprised by
food items majorly. Therefore, CRISIL Research believes that the increase in the consumer price index-linked
(CPI) inflation is transitory. A normal monsoon, as forecast by the India Meteorological Department (IMD), and
proactive steps taken by the government to manage food supply will rein in food inflation this fiscal. Latest data
suggests rainfall is 3% above normal so far, which has helped raise reservoir levels and supported sowing. Sown
area coverage so far is higher by 43.6 lakh hectare than normal as on date (as of August 5), with substantial progress
in pulses. Therefore, we believe it will take 1-2 months for the benefit of the rains to wash away the rise in food prices.
After the Reserve Bank of India (RBI) kept its policy rate unchanged at 6.5% at its August 9 meeting, we
expect the central bank to deliver a rate cut in October with further clarity on the monsoons and inflation trajectory.
We expect the average CPI to stay close to 5% this fiscal, assuming a favourable monsoon with adequate temporal
and spatial distribution. The resulting lower food inflation will offset higher services inflation. Risks to inflation could
emanate from: 1) High protein inflation, which has recorded double-digit growth for 14 consecutive months; 2) Service
inflation, especially in rural areas, which is keeping core inflation high and sticky; 3) Unfavourable temporal and
spatial distribution of rainfall in rest of August and September; and, 4) Surprise pick up in oil prices.
IIP growth inched up for the second consecutive month - growing by 2.1% on-year in June over 1.1% in May. While
the pace of growth still remains low, there was an improvement across the board. Not only manufacturing sector
grew positively (0.9%) for the second straight month, electricity and mining sectors too displayed better growth. The
improvement in manufacturing growth was primarily on account of consumer oriented sectors which grew by 3.5%
in June while industrial and investment oriented sectors were in red. In terms of use based classification, capital
goods segment continued to remain a drag (-16.5% growth) even as basic, intermediate and consumer goods
segment improved their performance. Within consumer goods segment, non-durable goods, which had hitherto grew
negatively, displayed healthy positive growth in June. Above-normal monsoon, which could improve rural demand,
along with the lagged impact of interest rate reductions, salary revisions and easier monetary conditions are expected
to support demand in future and boost industrial activity. We, therefore, expect industrial GDP growth to increase to
7.6% in fiscal 2017 from 7.4% in fiscal 2016.
Retail inflation remains high, on higher food inflation and unfavorable base effect

CPI inflation jumped up to 6.1% in July, led by a rise in food inflation, especially in egg, vegetables, pulses
and products, spices and sugar. Food inflation rose to 8.4% in July from 7.8% in June. Protein inflation also
rose to 14.8%, as inflation in egg and pulses increased in July.

Inflation was also pushed up due to an unfavourable base effect from last year. We estimate that
excluding the base effect inflation would have been close to 5.5%. Also, the month-on-month momentum in
overall inflation remained unchanged at 0.4% and in food inflation slowed down to 0.4% in July from 0.7%
in June.

Core inflation (excluding food, fuel, and petrol and diesel) stood at 5.1% in July from 5% in June, as inflation
edged up slightly in household goods and services, clothing and footwear, recreation and personal care and
effects.

Fuel inflation (including petrol and diesel) declined on the back of lower oil prices, to 0.9% in July.

Rural inflation inched up to 6.7% from 6.3% in June as did urban inflation to 5.4% from 5.3% in June. Food
inflation rose both in rural and urban areas.

Classification: INTERNAL

Inflation outlook

We expect CPI inflation to average at 5% in FY17, assuming a normal monsoon and proactive food supply
management by the government. A normal monsoon will soften food inflation and offset the upside risk to
overall inflation from higher crude prices and sticky services inflation. In addition, other risks to overall
inflation going ahead could emanate from a 1) closing output gap pushing up core inflation and 2) seventh
pay commission payouts. Also, key monitorables for food inflation are: 1) Monsoon; 2) Global oil and
commodity prices; and, 3) Pulses and oilseed inflation.

The recent increases in inflation have had an adverse impact on inflation expectations, raising the
inflation expectations for the next three month as well as for the next one year (as of the June 2016 RBI
survey).

Of the total inflation basket, items with inflation above 6% (the higher bound for the RBI inflation
target band of 4+/-2%) account for only 23% weight. Also these are majorly food items with 42% of the
food items in the inflation basket recording inflation above 6%. On the flipside, only 10% of non-food items
have inflation above 6%. Therefore, we expect the recent rise in inflation to be a blip, and favourable
monsoons to bring down food inflation in the coming months as food supply increases and the government
continues to take steps to ease out supply constraints and improve efficiency through reforms.

The recent GST bill, passed in the Rajya Sabha, is one such example which will bring down inflation in the
medium run. That said, in the short run, we believe GST implementation might result in increasing inflation
in the service category that currently experiences lower indirect tax rate.

Turning to monsoons, latest IMD data shows rainfall so far is 3% above normal (August 11). Rainfall is
deficient only in the east and northeast region by 16% of the long period average. While it is 10% and 15%
above normal in the northwest and central India, respectively, it is -2% of LPA in the peninsular region. Out
of the 36 sub-divisions, 85% of the total area of the country has received excess\normal rainfall. Bountiful
rainfall has also helped replenish reservoir levels from the lows seen in the beginning of the fiscal.

Despite a slow start to the monsoon season and a weak sowing start, 83% of the normal area under Kharif
crops has been sown as on August 5. This year, area coverage so far is higher by 43.6 lakh hectare than
normal as on date with area under rice, maize, coarse cereals, pulses and oilseeds higher than last year.
The most increase is recorded in pulses where sown area is 31.4 lakh hectare higher than last year, due to
higher coverage in Tur, Urad and Moong.

Crude prices have risen by over 30% since April. However, we expect oil prices to remain contained at $4045/barrel in 2016. That said, the benefit to inflation from the lower oil prices will decline this fiscal.

IIP Growth: Manufacturing growth displays gradual improvement

The Index of industrial production (IIP) recorded a growth of 2.1% on-year in June 2016, up from 1.1% in
the previous month. Not only is it the second consecutive month of positive growth but also the highest so
far this year. That said, the pace of growth still remains low. The improvement was seen across the board.
Manufacturing sector - the mainstay of IIP with ~75% weightage grew positively for the second straight
month by 0.9%, 30 bps up from its last reading. Eighteen of the twenty-two industry groups in the
manufacturing sector grew positively in June from the same month last year. Electricity sector growth, which
had unexpectedly slowed down in May, again propped up to 8.3% in June. Mining sector too expanded at
a healthy pace of 4.7% in the month.

The positive growth in manufacturing was led primarily by the consumer oriented sectors (3.5% growth)
whereas industrial and investment oriented sectors grew negatively (-0.7%) in June, displaying continuously
weak momentum. The key categories that contributed to the high growth of consumer oriented sectors

Classification: INTERNAL
3

highest so far this year were food and beverages (growing positively for the first time in last 14 months,
by 0.3%), textiles (5.5%) and motor vehicles (8.8%). On the other hand, a large decline in the production of
electrical machinery and apparatus (-46.1%) led to the fall in growth of industrial and investment oriented
sectors. Within this, some categories which managed to display healthy growth in June were chemicals
(4.5% growth), base metals (4.3%) and coke, refined petroleum etc. (7.6%).

According to use-based classification, the fall in the capital goods category intensified in June (-16.5%) from
May (-12.3%) even as all other categories displayed improvement. Both basic and intermediate goods
categories registered higher growth in the month. Aided by the positive growth in the consumer non-durable
category (1%) where growth had fallen in previous seven consecutive months production of consumer
goods improved to 2.8% in June from 1% in May.

Figures: CPI and IIP

Figure 1: Headline CPI remains high in June

Figure 2: Rural inflation higher than urban, as

favorable monsoons are yet to benefit rural prices

Headline inflation

Food inflation

Core Inflation

20

Rural CPI

Urban-CPI

18

16
14

12

10

RBI target of 4%

Jul-16

May-16

Mar-16

Jan-16

Nov-15

Sep-15

Jul-15

May-15

Mar-15

Jan-15

Nov-14

Sep-14

Jul-14

Jul-16

Apr-16

Jan-16

Jul-15

Oct-15

Apr-15

Jan-15

Jul-14

Oct-14

Apr-14

Jan-14

Jul-13

Oct-13

Apr-13

Jan-13

Jul-12

2
Oct-12

Source: MOSPI, CEIC, CRISIL Research

Figure 3: Rise in food inflation pushes up CPI

CPI (%y-o-y)
Weight

Dec-15

Jan-16

Feb-16

Mar-16

Apr-16

May-16

Jun-16

Jul-16

FY15

FY16

100

5.6

5.7

5.3

4.8

5.5

5.8

5.8

6.1

6.0

4.9

Food CPI

39

6.4

6.8

5.4

5.2

6.4

7.5

7.8

8.4

6.4

4.9

- Cereals & Products

10

2.3

2.2

2.2

2.4

2.5

2.6

3.1

3.9

5.2

1.8

- Pulses & Products

45.8

43.3

38.5

34.2

34.2

31.6

26.9

27.5

7.9

31.7

- Vegetable

4.4

6.4

0.7

0.5

5.0

10.8

14.8

14.1

4.8

1.7

- Milk & Milk Products

3.9

3.9

3.7

3.3

3.4

3.5

3.4

4.1

10.4

5.2

Protein Inflation

20.4

20.6

18.5

17.4

17.7

17.3

14.3

14.8

6.7

15.1

Fuel & Light

5.4

5.3

4.6

3.5

3.0

2.9

2.9

2.7

4.2

5.3

Transport and communication

excl. Petrol & Diesel

3.4

3.1

3.2

3.1

2.9

3.0

3.2

3.2

2.5

3.3

Core CPI

52

5.4

5.2

5.4

5.1

5.3

5.2

5.0

5.1

5.9

5.4

- Housing

10

5.1

5.2

5.3

5.3

5.4

5.4

5.5

5.4

7.0

4.9

- Education

5.6

5.5

5.8

5.7

5.5

5.8

5.4

5.1

7.2

6.3

- Personal care & effects

3.6

3.4

4.9

5.7

5.7

6.1

5.9

7.3

3.5

3.7

4-6%

6-8%

8-10%

>10%

Headline CPI

Below 4%

Note: Food CPI excludes paan, tobacco, prepared meals and beverages. Core CPI excludes food CPI, fuel and light, and petrol and diesel.
Source: CEIC, Central Statistical Office, CRISIL Research

Classification: INTERNAL

Figure 4: IIP Performers and laggards

IIP Overall

Manufacturing

Mining & Quarrying

Electricity

Consumer oriented

20.0

Industrial and investment oriented

20.0

15.0

15.0

10.0
5.0

10.0

0.0
5.0

-5.0
0.0

Jun-16

Apr-16

Feb-16

Dec-15

Oct-15

Aug-15

Jun-15

Apr-15

Feb-15

Dec-14

Oct-14

Jun-14

Jun-16

Apr-16

Feb-16

Dec-15

Oct-15

Aug-15

Jun-15

Apr-15

Feb-15

Dec-14

Oct-14

-20.0

Aug-14

-10.0

Jun-14

-15.0

Aug-14

-10.0

-5.0

Source: CSO, CRISIL Research, Note: All values in % y-o-y

Figure 5: What the latest trend says about sectoral growth

% yr

Weight %

Nov-15

100

-3.4

-0.9

-1.6

1.9

0.3

-1.3

1.1

2.1

3.3

0.6

Mining

14

1.7

2.8

1.5

5.0

0.3

1.1

1.4

4.7

0.4

2.4

Manufacturing

76

-4.6

-1.9

-2.9

0.6

-1.0

-3.7

0.6

0.9

3.7

-0.7

Electricity

10

0.7

3.2

6.6

9.6

11.8

14.6

4.7

8.3

2.2

9.2

General

Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Q1 FY16 Q1 FY17

Use-based classification
Basic

46

-0.5

0.7

1.9

5.4

4.4

4.7

3.8

5.9

4.6

4.8

Intermediates

16

-1.5

1.5

2.8

4.9

4.2

2.3

3.9

6.1

1.6

3.8

Capital goods

-24.4

-18.6

-21.6

-9.3

-15.3

-25.0

-12.3

-16.5

2.2

-16.6

30

1.0

3.2

-0.1

0.6

0.6

-1.9

1.0

2.8

2.6

-0.2

12.2

16.6

5.6

10.4

10.1

11.8

6.0

5.6

4.5

10.7

21

-4.8

-2.7

-3.2

-4.9

-4.9

-10.8

-2.3

1.0

1.7

-6.8

Consumer Goods
-Durables
-Non durables
Contraction

Grow th slow ing

Grow th rising

Source: CSO, CRISIL Research, Note: All values in % y-o-y

Classification: INTERNAL
5

Analytical Contacts:
Dharmakirti Joshi
Chief Economist, CRISIL Ltd.
dharmakirti.joshi@crisil.com

Adhish Verma
Economist, CRISIL Ltd.
adhish.verma@crisil.com

Media Contacts:
Shamik Paul
Media Relations
CRISIL Limited
D: +91 22 3342 1942
M: +91 9920893887
B: +91 22 3342 3000
shamik.paul@crisil.com

Khushboo Bhadani
Media Relations
CRISIL Limited
D: +91 22 3342 1812
M: +91 72081 85374
B: +91 22 3342 3000
khushboo.bhadani@crisil.com

Sakshi Gupta
Economist, CRISIL Ltd.
sakshi.gupta@crisil.com

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