Given the Chinese slowdown and the turmoil in its markets, India appears to be on relatively safe grounds. But despite the big oil bonanza—which has helped the twin deficits as well as the rupee—the recovery in the economy is turning out to be a slow affair. Factory output for November contracted 3.2% y-o-y, the first fall since October 2014—to be fair, November had less working days thanks to Diwali, so the number should be read together with the October growth of 9.9%, and there were also the Chennai floods. Even so, the 24% y-o-y fall in capital goods is worrying as it seemed to be recovering rather well—the numbers, of course, have met with scepticism because they don’t tally with the order books of engineering companies which have either been shrinking or growing very slowly. Which is why, given how the performance of the power segment too has been uneven, industrial recovery is coming in fits and starts.
Economists at Bank of America point out that the main reason why—after netting out Diwali as well as base effects—industrial growth is so poor is that high real lending rates continue to hurt production. While visibility on demand alone can convince companies to invest, reducing the cost of money can help at least bolster profitability—with negative WPI, the real borrowing rate for industry is 12-14%, making investment impossible. While the obvious solution would be to cut rates, this is not possible since, with RBI now driven by inflation-targeting, the scope for rate cuts is limited. Also, RBI is using CPI inflation instead of WPI—CPI has a very high weight for food items which are not fully determined by demand and supply, but by structural factors. In December, retail inflation rose 5.6% y-o-y primarily on account of higher food prices—for proteins—and, to some extent, due to an increase in fares for public transport. Though cuts in small savings contemplated over the next few days will help transmission, further cuts by RBI cannot take place until the CPI-based inflation-targeting model is junked.