Big bounce in industrial growth an aberration, not reality
The growth in industrial production rose sharply to 9.8 per cent in October from 3.8 per cent in September, above consensus expectations. However, the jump was primarily owing to base effects linked to the timing of the Diwali festival, which fell in October 2014 vs November 2015, resulting in a lower number of working days a year ago and hence a weak base (October 2014: -3.9 per cent month-on-month). A similar phenomenon was witnessed in October 2012, when IP growth surged to 8.4 per cent year-on-year from a -0.7 per cent in the prior month. Adjusting for the base effect, we believe the underlying trend remains in the 4-5 per cent range, indicating a gradual industrial recovery. While growth is picking up, the IIP print exaggerates the trend. Consumer durables and capital goods growth continued to drive the industrial recovery. November IP growth is likely to decelerate sharply owing to the Diwali holidays; hence, average IP growth in Oct-Nov should reflect the true picture. We expect GDP growth to pick up to 7.6 per cent in FY16 from 7.3 per cent in FY15, led by higher discretionary demand (low inflation), lower commodity prices, higher public capex and lagged effects of monetary policy easing. On the supply side, mining growth picked up, while electricity growth remained robust. Manufacturing output growth also rose sharply to 10.6 per cent from 2.9 per cent in September, albeit inflated by the one-off festival effects. On the demand side, the upturn continued to be driven by consumer durables output growth, which rose sharply to 42.2 per cent year-on-year from 8.4 per cent in September. Gems and jewellery and passenger cars, which are part of consumer durables, together contributed 2.5 percentage points to October IP growth. However, even discounting for the one-off effect in the IIP print, consumer durables have been consistently outperforming, reflecting a sustained improvement in discretionary demand. Capital goods output growth also surged to 16.1 per cent year-on-year from 10.3 per cent in September, owing to base effects and led by the volatile cable, rubber insulated segment. Consumer non-durables remain the weak link (-1.2 per cent month-on-month), reflecting weak rural demand. November IP growth is likely to decelerate sharply, owing to fewer working days (Diwali in November) this year vs last (Diwali in October). Hence, the average rise in October-November should reflect the true trend. In our view, the underlying trend remains in the 4-5 per cent range, indicating a gradual industrial recovery, led by improving domestic demand, even as external headwinds remain strong. High frequency indicators such as passenger car sales, medium and heavy commercial vehicles, aviation passenger traffic, import (excluding oil, gold) volumes and indirect tax collections all indicate a recovery is under way. In our baseline, we expect GDP growth to recover to 7.6 per cent in FY16 from 7.3 per cent in FY15, led by improving discretionary demand (low inflation), frontloaded public capex, low commodity prices and the gradual transmission of past rate cuts (125bp).