India's September CPI inflation along expectations, production surprises

Along expectations, fading base effects lifted September CPI inflation to 4.4% YoY from Aug's 3.7%. Crucial southwest rains were 14% below long-term average between June and September, with the fallout by far limited mostly to pulses and few common vegetables. This reflected in the notable 4.3% jump in food inflation in September, double the pace of the month before. A sharp month-on-month rise in vegetables (strongest pace in more than a year) and ~30% jump in lentils were the main contributors. Pre-emptive short-term measures and an increase in imported supplies are expected to rein in any trickle-down impact in the weeks ahead. 

Non-food pressures have meanwhile stabilised. Global crude prices held near lows, weighing on the related sub-components, especially transport and communication. The latter declined -0.6% YoY in September vs 0.1% rise in Apr-Aug15. Contribution by other service sector segments has flatlined in recent months, while core CPI stays subdued below 5%. 

Against this backdrop, the Reserve Bank of India had drawn confidence from the evolving inflation outlook and front-loaded 125bps cuts in first nine months of this year. A pause is likely to follow in December, with odds of further cuts in Mar16 quarter to rise if inflation undershoots the 5.8% official estimate and external risks abate. 

Out simultaneously, Aug industrial production (IP) outpaced expectations, rising 6.4% YoY from Jul's 4.2%. The breakdown saw capital goods production jump sharply along with a third month of double-digit rise in consumer durables (helped by base effects) while non-durables stay soft. There was broad-based pick-up in manufacturing, mining and electricity generation, signalling that supply-side constraints are been evened out gradually. 

Digging deeper, capital goods output jumped 21.8% YoY from 4% rise in the prior four months. Supportive base effects, lumpy and volatile nature of this sector alongside distortions from a sharp jump in insulated cable/rubber subcomponent (punched above its weights to add +1.6ppt to headline IP), influenced the headline print. Consumer goods output found support from a modest pick-up in non-durables and a sharper rise in durables output. Looking ahead, base effects will provide support to durables output, along with easing inflation and pullback in financing costs. 

On the supply-side, heavy-weight manufacturing output rose jumped 6.9% YoY sharpest rise since late-2012. Here, while the performance of metal industries remains mediocre, a one-off sharp rise in electrical machinery and apparels propped the headline print. Electricity generation is up a modest 3.2% so far this fiscal year, outpacing mining output at 1.2%. 

Overall, after annual rise of 2.8% last year, production is up 4.1% in first five months of FY15/16. These trends should find further support from government spending-led boost to infrastructure investments, lower financing costs and easing inflation, which are expected to underpin the cyclical upturn in industrial activity.