Sep WPI inflation inches up from trough; highway projects : DBS Research Report

Sep WPI inflation declined -4.5% YoY inching up from -5% drop in Aug, lifted by fading base effects and modest rise in food price inflation. Food inflation rose 0.7% YoY after two months of decline, underpinned by higher vegetables and pulses, while protein costs subsided. Disinflationary forces were evident across other components, but was starkest in the fuel/light and minerals category. Fuel (& light) prices fell 17.7% YoY while minerals contracted 30.5%, both in red for a year.

There were some signs of let-up in the manufacturing products inflation which fell -1.7% from a sharp -1.9% in Aug. However, rather than durable improvement in profit margins or pricing power, much of the bounce is likely due to fading base effects. Core WPI measure held in red for the seventh straight month. As emphasised before, bulk of the weakness in the WPI inflation has been on account of higher weightage of tradables in its basket and the latter's sharp fall (see components' contribution in the accompanying chart).

Fading base effects are likely to lift WPI headline readings into black in early-2016, but remain tepid. Favourably, lower WPI inflation suggests pipeline pressure continue to wane, validating expectations that CPI inflation will also remain within targets. However, concurrently there is a debate whether deflation might be a bigger risk than inflation for India. This emanates from low GDP deflator and a sharp decline in WPI inflation. In our view, deflation, in its strictest sense, is not material risk for India (IN: RBI - another window opens; 22Sep15). Problematic deflation follows from weak demand. It typically involves corporates/ manufacturers persistently lowering prices to boost demand while households postpone purchases on expectations that prices would fall further, leading to a vicious cycle.

Higher frequency data indicators do not suggest that India is in midst of such an environment. Even if we set aside the 7% headline growth numbers, underlying momentum is slow but turning up. Industrial production growth has stabilized at around 4% pace, credit growth is steadying at lows, rural wages have bottomed and funding costs are set to ease. All these factors should boost investment, while consumption and confidence indices are on the mend. Adjustments to salaries/ pensions for armed personnel and seventh pay commission next year should also lift demand. Hence, while price pressures are off the boil in the economy, it is not at a state which will require the authorities to undertake aggressive rate easing or out-of-the-box support.

On a related note, the cabinet yesterday approved an one-time funds infusion for national highway projects that have stalled in recent years, which is expected to revive activity in the sector. The exact quantum of funds is unclear, however as a sub-rule, more than 50% of the project should have been completed by Nov, 2014 to qualify for this support. Kickstarting work here will also ease the burden on banks' balance sheets, where infrastructure projects are amongst the top contributors to the bad and restructured loans.

Source : Equity Bulls

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