Industrial production (IP) growth slowed to 7.1% year on year (yoy) in July, in part due to base effects from July 2006 when IP had grown by 13.2% yoy (see Exhibit 2). The IP numbers for June were also revised downwards to 9.0% yoy from 9.8% yoy. On a month-on-month basis, the IP Index (IPI) fell by 0.9% in July compared to a fall of 1.3% in June. In 1QFY2008, the IPI had grown by 10.8% yoy and in FY2007 by 11.5% yoy.
A fall in consumer durables growth causing IP slowdown. Consumer durables fell by 3.2% yoy in July 2007 compared to a 16.1% yoy rise in July 2006 due to rising interest rates. Capital goods grew by 12.9% yoy compared to 18.3% yoy in July 2006, higher than headline IP suggesting continued capacity expansion. Growth is still being driven by investment demand with capital goods having grown at an average of 18% in the past 24 months (see Exhibit 3).
We think the July IP numbers exaggerate the moderation in activity due to base effects. Although significant monetary tightening by the central bank and the sharp rupee appreciation earlier this year is having an impact on activity, the underlying momentum is still strong. Co-incident indicators, such as growth in cement production, cellular subscribers, and motor vehicle sales have moderated only a notch in recent months (see Exhibit 4). Indeed, the PMI actually accelerated in August to 57.9 from 52.9 in July and 53.2 in June. We believe activity will continue to moderate from the higher-than-expected 9.3% yoy growth in 1QFY2008 to 8.2% yoy by 4QFY2008.
Growth story on track. We have recently increased our GDP growth forecasts for FY2008 to 8.7% from 8% on the back of continued strength in investment demand, higher-than-expected 1QFY2008 GDP and a better-than-expected monsoon which bodes well for the agriculture sector employing 60% of India’s work-force. A good crop will be a positive supply shock, boosting incomes and depressing primary commodity prices. Therefore we expect inflation to remain under 5%, although there are upside risks from higher oil prices. We do not expect any further change to benchmark interest rates in 2007, as capacity expansion is in train, inflation has come off its peak and money growth is declining on a sequential basis.
