Eyes to the skies

Data released in the last few days presents a mixed picture of the economy. While industry performed well in May, inflation rose faster than expected and exports shrank 22% on-year in June. Moreover, monsoon, although normal, has been quite uneven in its spread over time and geographies.

Industrial production logged 5.2% growth in May, very much in line with what the Purchasing Manager's Index (PMI) in the strong expansion zone at 58.7indicated. PMI at 57 in June, although lower than in May, implies healthy manufacturing growth in June as well. Two factors can pull industrialperformance down in the coming months. The first is a slowing global economy, which is already impacting exports, and the second, monsoon, if itsperformance is sub-par. Inflation at 4.8% in June came in higher than expected, largely due to a spike in inflation in pulses and vegetables. This comes on theback of double-digit inflation in cereals and spices. The key risk to inflation - particularly food inflation - is from monsoon, which has been uneven so far.

Rains have moved very swiftly from deficient to excess at the aggregate level, but their distribution has been highly skewed. Some rainfed areas have received scanty rainfall, while northwest India, which is well-irrigated, saw a large surplus that led to floods. As on July 19, 10 out of 36 sub-divisions recorded deficient rainfall, while another 11 recorded excess/large excess.

This has delayed sowing - particularly for rice and pulses - which is now catching up. The sowing season is still on, and the lost ground can be fully covered, if rains behave well. The worry is primarily for pulses, where crop damage last year and monsoon turbulence this year have created upside pressure on inflation. Inflation in pulses already surged to 10.5% in June (refer to our report 'Taking the pulse' for more on this). An El Niño event, associated with scanty rains, continues to be risk not only for India but for some other Asian nations as well in the second half of 2023.

Monsoon is, therefore, a key monitorable this year, from the perspective of food inflation, as well as the sustenance of the nascent recovery seen in the rural economy. Food has a 46% weightage in the Consumer Price Index (CPI) and can swing it above the tolerance band if price pressures accentuate, as it has done in the past.

What do these developments mean for the forthcoming monetary policy? While a transitory spike in food inflation is typically ignored by the Reserve Bank of India (RBI), sustained increases constrain monetary policy easing. We expect the RBI to keep the rates and stance unchanged in the forthcoming policy. That said, rate cuts are expected early next year.