Economy: Pre-GST disruptions lead to IIP contraction - Kotak

Pre-GST disruptions lead to IIP contraction. June IIP growth at (-)0.1% was a reflection of the production slowdown before the GST implementation from July 1. Post the demonetization-led disruption in production, industrial production has been further weighed down by GST-led inventory destocking. We expect this adjustment to be short-lived and production should normalize within the next 2-3 months. We believe IIP growth is near its trough but recovery will be prolonged rather than V-shaped.

Pre-GST jitters show up in June IIP growth

June IIP growth at (-)0.1% (Kotak estimate of (-)0.7%) will likely be a transient dip led by GST-related issues. Even as the June 2017 IIP level was in line with our estimate, downward revision of historical data (April 2012 onwards) led to a marginally lower-than-expected contraction. June 2016 growth was revised down to 8% from 8.9%. May 2017 growth was revised up to 2.8% from earlier estimate of 1.7%.

Sector-wise, manufacturing growth was at (-)0.4% after 1.2% in May. Sequential mom contraction in manufacturing was at 4% in June. Within manufacturing, 15 out of the 22 groups have shown negative growth with 'manufacture of electrical equipment' has shown the highest negative growth of (-)20.1% followed by growth of (-)11.1% in 'manufacture of fabricated metal products, except machinery and equipment', and growth of (-)10.5% in 'printing and reproduction of recorded media'. On the other hand, positive growth was seen in sectors such as 'manufacture of pharmaceuticals, medicinal chemical and botanical products' at 19.2% and 'manufacture of furniture' at 11.7%, and 'basic metals' at 2.7%.

Mining production grew 0.4% after (-)0.9% in May. Electricity production growth was at 2.1% against 8.7% in May. 1QFY18 IIP growth was 2% against 7% in 1QFY17 and 2.6% in 4QFY17.

Capital goods production continues to slump along with consumer durables

Capital goods production growth slumped to (-)6.8% after a contraction of (-)3.9% in May. For 1QFY18, average growth in capital goods has been (-)4.5% symptomatic of the weak investment cycle in the economy. Meanwhile, consumer durables production saw a growth of (-) 2.1% compared to (-)4.5% in May. This is the seventh consecutive negative print and summarizes the weakness in the sector following demonetization and GST. However, non-durables sector production growth remained positive at 4.9%. Notably, some sectors such as 'gems and jewelry', and 'cut and polished diamonds' exhibited high positive growth.

IIP growth near its trough but will see a prolonged recovery phase

Lead indicators such as PMI manufacturing indicate that there has been a contraction in business sentiments in July. However, we believe that GST-related slowdown will be short-lived and production should normalize over the next 2-3 months. More importantly, the progress in industrial sector is likely to be prolonged rather than a V-shaped recovery. We are possibly at the trough of the cycle. However, sustenance of a recovery will be from improvement in both corporate and bank balance sheets, improvement in capacity utilization, and global economic recovery. In FY2018, we do not expect much uptick in GVA growth and estimate it at 6.8% (FY2017 at 6.6%) with certain drivers such as government expenditure, 7CPC-led consumption growth, and agriculture output being absent or much weaker compared to FY2017. 1QFY18 GVA growth is unlikely to show much buoyancy and we estimate it at around 6% compared to 56% in 4QFY17 and 7.6% in 1QFY17.

Source : Equity Bulls

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