Economy: Inflation firms up, production disappoints - Kotak

Inflation firms up, production disappoints. The uptick in March CPI inflation was largely attributable to unfavorable base effect and sequential pickup in core inflation. While we expect around 50 bps of downside to RBI's March 2018 estimate of 5%, the headline inflation is likely to still remain higher than the medium-term target of 4%. Further, sticky core inflation leaves limited scope for further monetary easing even as growth is expected to remain tepid. We expect RBI to maintain status quo in FY2018.

CPI inflation surges to a five-month high

CPI inflation accelerated to 3.81% in March compared to 3.65% in February (Kotak: 3.9%, consensus: 3.95%), led largely by unfavorable base effect and pickup in core inflation. Food inflation remained nearly flat at 1.93% (2% in February). On a sequential basis, the uptick was primarily led by fruits (2%), vegetables (0.8%) and sugar (0.7%). Meanwhile, price of pulses continued to contract sequentially ((-)5.5%). High frequency data for mandi prices are indicating a further pickup in fruits, vegetables and sugar prices. Meanwhile, fuel and light inflation surged to a 19-month high of 5.6% led by 1% mom increase in fuel prices.

Core inflation remains sticky

Core inflation inched marginally higher to 4.79% from 4.75% in February; printing a third consecutive month of sequential increase (0.3% mom compared to 0.4% in February). Within core inflation, household goods and services (0.4% mom) and healthcare (0.3% mom) witnessed a faster pickup in prices. Transport and communication (T&C) category increased 0.2% mom with the annual print at 6% (5.4% in February). Refined core inflation (core inflation ex-petrol and diesel within T&C) probably remained stable around 4.2%.

Industrial production contracts sharply

February IIP growth surprised on the downside at (-)1.2% (consensus: 1.5%) with across-the-board sequential contraction. While mining sector production expanded 3.3% along with electricity production growth of 0.3%, manufacturing sector growth was at (-)2%. Within the manufacturing sectors, key sectors such as food products ((-)21.7%), textiles ((-)4.1%), non-metallic mineral products ((-)13.2%), fabricated metal products ((-)3.9%), etc. showed sharp contraction. Capital goods production contracted 3.4% while consumer goods contracted 5.6%. Overall, the IIP growth (which needs to be updated and rebased soon) continues to be volatile and implies that investment cycle is yet to see any firm signs of recovery.

RBI to stand pat in FY2018

In its April policy, RBI maintained its hawkish stance on inflation and scaled up its inflation trajectory by an average of 25 bps. While we agree that there is limited downside to the core inflation, a sharp uptrend is also unlikely given the persistence of significant excess capacity amid the slower narrowing of output gap. Further, we expect prudent food management policy coupled with increased buffer stocks to further cap the food inflation. We expect the headline inflation to hover around 4.5% by March 2018 (ex HRA), around 50 bps lower than RBI's estimates. Nonetheless, we expect a status quo in FY2018 as RBI aims for the 4% target and continues to monitor the likely upside risks emanating from (1) El Nino-led monsoon risks, (2) higher input prices, (3) GST implementation, (4) 7CPC-led HRA reset with probable second-round impact, (5) possibly higher than budgeted states' fiscal impulse, (6) rural wages and (7) global reflationary risks.

Source : Equity Bulls

Keywords