Too early to conclude an economic recovery

Strong growth in capital goods production in Feb ’09 overshadowed the 1.2% dip in IIP – index of industrial production. It spread the optimism across the market. Few even feel that the IIP has bottomed out and we may soon see a recovery in industrial production led by demand in investment. But it will be too early to conclude a recovery if we consider other macro-economic indicators and the items driving the growth in capital goods sector.

A growth of 10% in capital goods production in Feb ’09 was largely on account of strong rise in production of electrical items or related products such as insulated cables and wires, cooling towers, electric generators, protection system and switch boards etc. Acceleration in production of diesel engines was another driver.

In short, it is the continued public and private investment in power sector that is driving the production of capital goods. In contrast in the past, growth was visible across the board. There is, however, a likelihood of slowdown in investment in the power sector due to rising fiscal deficit and increasing cost of capital.

Our skeptical outlook is also supported by a secular slowdown in growth of capital goods in last one year. In past six years the sector’s production expanded at high double digits. During April ’08 to February ’09 however, the growth moderated to 8.8% compared to 17.7% in the corresponding period last year.

IIP is still in on a downward sloping trajectory. Moreover, almost half of the items in capital goods recorded fall in their production. There are other indicators, which points towards a moderation in investment activity.

The growth in investment demand denominated by fixed capital formation slowed down to 10% in the first three quarters of FY09 against a growth of 14% in the corresponding period of the previous year. Deceleration in import of industrial inputs and lower credit off take by commercial sector from the banks confirmed this trend.

Imports of industrial inputs moderated to 23.8% during first seven months of FY09 from 31.3% in the comparable period while non-food credit grew 17.5% during FY09, lower than growth of 23% a year ago. Many investment projects have deferred on account of liquidity crunch and lower demand outlook. Going forward, anticipation of lower corporate profitability will further drag down the investment expenditure.

A sustainable revival in industrial output will require a pick-up in the real economy. But so far the enabling environment for investment activity is far from encouraging. The consumption demand both domestic and external is expected to be weak in coming months. There was dip in exports for consecutive six months in FY09. The consumption demand, which is a driver of domestic economic growth, is showing signs of fatigue.

For example, auto sales and production of consumer durables continue on a downward spiral. The extent of job losses and salary cuts and high food prices put further pressure on consumption demand. In short, the scenario is going to be tough and even India Inc is also pessimistic about the business environment in coming six months.

The D&B’s Composite Business Optimism Index for the June ’09 quarter fell to a new low of 93.8 recording a decrease of 39% on a year-on-year basis. It was observed that five out of the six optimism indices – volume of sales, net profits, selling prices, new orders, and employee levels have registered decreases as compared to the previous quarter.
The only optimism index to record a growth of 7% was the level of inventory. The sentiment has been bearish across all the sectors with companies in capital goods and consumer goods the least optimistic.

To conclude we can say a recovery of momentum in growth led by investment is a distant possibility at this time. However, there are some positive factors like gradual reduction in lending rates, some signs of stability in US economy which are raising hopes for turning the trend upside at least by the beginning of later half of FY10.