"WEAKER” IIP and “STRONGER” INFLATION NUMBERS: CAUSE FOR ALARM OR CELEBRATION?

Tuesday’s Index of Industrial Production (IIP) and retail inflation data releases have sent opinions abuzz around the market.  Many are alarmed at what is seen as a sensational drop of IIP from 7.5% in January 2018 to a relatively anaemic 1.7% for the same month this year.  In addition there has been a creep up of retail inflation from 2.05% in December 2018 to 2.57% in January 2019.  Does this spell stagflation? Or impending slowdown to the extent of falling off the 7% growth track?  Or is the implication completely different from these conclusions?  Let us share how it appears from our perspective.

Firstly, we address the inflation issue.  Undoubtedly we see a creep up, but it is gradual.  So what is causing it? Let’s take a step back and note that when inflation is cost push, it tends to occur in sluggish bursts, driven by rising factor costs that gather momentum uncontrollably. 2.05% to 2.57% is no burst.  And there is no evidence of uncontrollable factor cost rises:  i.e., no wage increases, land price increases or interest rate increases.  In fact, all three have been quite muted in the recent past.  Hence, we can quite safely rule out cost push inflation, which would have been cause for alarm.

If the above is ruled out, the obvious cause is demand pull, a cause for cautious celebration. In other words, gradually strengthening retail pocket books, enabled by the lean inflation period of the past few months, are driving up retail prices.  But in the absence of wage inflation, it must be stronger investment returns.  Hence we look to the markets.  And truly enough, the rally in Bank Nifty and the continued strengthening of the broader market since the lows of November 2018 underline the positive aspect of the inflation number.

So what about the slump in IIP?  Again, however, we observe that there are two aspects to it.  First is that the base effect from a year ago is significant.  The year 2018-19 has been exceptionally strong and what appeared as 7.4% in January 2018 would not necessarily be as large as this with the consistent growth that has been clocked through the year.  The second is that the previous month’s number was 2.4% which has slowed to 1.7%, a fact much less dramatic than the 7.4% to 1.7% change.   So all told there is no cause for alarm from the IIP perspective.

Hence what we see this data release signalling is a happy augury: concurrently strengthening demand and stronger investment returns, benign inflation, and their implications, i.e., increased production capacity and strongly continued growth.  Given the low levels of inflation both in retail and in real estate, we see fairly valued asset prices, which are what investors seek. In addition, we note that volume on the call side in weekly options around the announcement has been significant and the calls have yielded strong returns.  This is positive news, and cause for celebration.  The markets have endorsed it, and we expect will continue to do so.