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Rains lose momentum

The agri-critical SouthWest monsoon lost momentum into August, entering a dry spell. The month accounts for a third of the rains during the southwest period (Jun-Sep) and ~20% of the annual rainfall. The monthly run-rate fell by a record 36% deficit in August (see chart) from a 13.5% surplus in July, raising the risk that the overall southwest season would end with a below normal or deficient rainfall. As of 3-Sep, the cumulative rainfall stands a deficit of -11% of long-term average, accompanied by an uneven geographical spread – 18% shortfall in the east & northeast India, -14% in southern peninsula, a 12% fall in central India, while the northwest region was 0%. With two-thirds of the key farm producing regions, heavy-weights like South and Central India, experiencing a shortfall in rains, crop yields and harvests are likely to be impacted this year.

The sowing of the summer crop (kharif) is nearly flat from the comparable period last year, marked by a 3.7% rise in the planting of the crucial rice crop on one end, whilst pulses are down the most -8.5% by early-Sep (see chart).

Higher rice sowing is encouraging considering the elevated cereals inflation; however, pulses, oilseeds and other cash groups are set to miss last year’s levels, suggesting commodity prices will stay high in the near-term.

Setting the stage for a weaker handover to the winter crop – reservoir levels have also been affected by the dry patch in August. Water level at major reservoirs now stand at 23% below last year’s levels (see chart) and 7% below the 10Y average, as of late-Aug.

Arid conditions in August were likely magnified by the risk of El Nino, which continues to play out in the background. The Southern Oscillation Index (see chart) has returned to the area which is considered a potential El Nino weather. The commonly viewed NINO readings have also been gradually on the rise, notwithstanding the positive the Indian Dipole Index.


Fiscal defence to contain prices

Monetary policy is a blunt tool in arresting supply-side price pressures. Fiscal defence is a more potent means, instead. The government has undertaken and continues to explore a mix of measures, including market intervention efforts, export restrictions, and relaxation in imports, few of which we touched upon in India: RBI maintains a prudent hawkish pause. In addition:
 

• Export restrictions: the ambit of constraints on rice have been expanded to include a 20% tax on parboiled rice exports, and a minimum export price on basmati variant, in addition to ban in shipments of non-basmati white rice. Singapore, Mauritius, and Bhutan have been exempted on food security grounds. Domestic rice stocks are above minimum buffer norms but lower than the past five years as of Aug23. Asian benchmark prices are up by a third, at a time when many of staple-dependent regional countries are stepping up imports to prevent a supply crunch locally. Separately a 40% tax was imposed on onion shipments. Press reports suggest that mills might be banned from sugar exports in the upcoming season beginning October, to fulfil domestic demand and produce ethanol from surplus stocks. As it stands, sugar exports by mills were capped at 6.1mn tons until Sep23, down from a record 11.1mn tons the previous season
• Relaxation in imports: Imports of pulses have been increased after the earlier move to impose stockholding limits, as prices of four staple lentils are up an average 12% yoy in Aug23 from 2%yoy in Jan23
• Non-food measures: The cost of cooking gas LPG has been cut by INR200, amounting to ~18% reduction in Mumbai, for the beneficiaries of the Pradhan Mantri Ujjwala Yojana (PMUY) program. This could help lower inflation by ~0.1-0.2pp. While this move could add to the budgeted INR76.8bn (0.03% of GDP), ahead of state elections in 2H23 and general polls in May24, public sector oil marketing companies (OMCs) will reportedly absorb this increase first, while awaiting clarity from the government. Taking cue from this reduction, oil marketing companies also lowered the commercial LPG prices, effective Sep1.
• Social support: With farmers unable to benefit from high global prices (due to export restrictions) and need for higher social assistance, we expect some support for the farm and broad rural sector in the weeks ahead. Press reported that a 8% increase in the rabi (winter crop) minimum support prices might be on the cards to improve procurement, especially wheat.

Domestic media had reported that the government might consider allocating up to INR 1trn towards fighting food and fuel inflation, by rejigging existing ministerial allocations. This might be accompanied by plans to reduce taxes on local fuel prices and import tax on essentials. After cooking gas, expectations have risen that lower petrol/ diesel prices might follow, via excise duty cuts. Last such move was undertaken in May22 to curb inflation. While a jump in global international old prices lowers the window for a price cut, excise duty reductions might allow for a move lower in the retail pump prices, ahead of a busy election calendar. Timing might also coincide with approaching festive period. Prorated for 2HFY24, total fiscal cost might be to the tune of 0.1-0.2% of GDP.

Overall, the government has been focused on frontloading capex expenditure to deliver on the promise of higher multiplier to growth. Nonetheless, a heightened need to support the economy and address inflationary risks in 2HFY might necessitate additional spending, ahead of a busy state polls and general election calendar. Any strain on the fiscal balance will, however, be address by reallocation amongst the spending heads rather than a material slippage in the budget metrics.


Inflation and policy implications

Food was responsible for all the increase in the headline July inflation at 7.4% vs 4.8% in June, with sequential MoM rise three times that of the monthly average in the past nine years. Vegetables led the pack (37% yoy) due to inclement weather and contributed to ~90% of the rise in food, accompanied by pulses up 13.3% and cereals (including rice) at 13%.

Into August, 45% of the food segments for which high frequency retail data is available, eased on month-on-month basis, including one of the key pain points i.e., tomatoes. On year-on-year basis, however more than 60% of the items continued to increase. Onions joined the camp, up 17% yoy in Aug vs 4.5% in Jul.

Our consolidated weighted average proxy for August continues to point towards an overall stickiness in food inflation (see chart). Building this into the headline, we expect August CPI inflation to stay above 7% yoy before turning back into the 6% handle in Sep23. LPG prices have been lowered, alongside which more impact of the easing measures is likely to reflect in the Sep prices. We will also monitor the rigidity in international oil prices, even as domestic fuel remains unchanged.

We lift our FY24 CPI inflation forecast to 5.5% yoy (upside risks) from 5.2% earlier, with core at 4.5% average. Minutes from the RBI MPC’s July meeting reinforced the central bank’s preference to tolerate the near-term surge in vegetables, counting on a seasonal correction late 3Q onwards, which could help bring headline inflation back into the target range. View on growth was sanguine, which came to pass in the 2Q23 (1QFY24) GDP numbers (see next section). These combined with high frequency food prints showing signs of softening, back the case for a pause in October.


Growth kickstarts FY24 on a strong note

Highlights

Real GDP growth in 2Q23 (1QFY24) rose 7.8% yoy, above our forecast of 7.5% and up from 6.1% in the quarter before. This marks the fastest pace of growth in nearly a year, also growing on seasonally adjusted basis. The supply-side gauge GVA also rose 7.8% from 6.5% quarter before.  Nominal GDP eased to 8% yoy from 10.4% quarter before on lower deflators – latter decelerated to 0.2% yoy from 4.3% in 1Q23. Spurt at the start of the new fiscal year was propelled by strong domestic demand i.e., consumption and investments, and strong services from the supply end, which offset headwinds from a weaker external environment. Discrepancies surged while base effects helped.

Key takeaways

On the demand end
 

• Domestic demand quickened to 5.9% from 4.8% in the Mar23 Q. Under the hood, private consumption fared well as high frequency numbers indicated, rising 6% yoy vs 2.8%, contributing most to the headline and reflecting the relief from slowing inflation
• Gross fixed capital formation rose 8% yoy, driven by frontloading in capex expenditure by the central and state governments. Centre’s expenditure had risen 59% yoy by Jun23, outpacing total spending, which increased by a modest 10.8% in the same period.
• Along expectations, external trade stayed weak, with goods & service exports shrinking 7.7% yoy while imports were up a strong 10%. This led the contribution from net exports to decline 4.4percentage points, highest since Mar 2018.
• Relative to pre-pandemic levels, consumption is up 15% yoy, besides 7% lift to fixed capital investments by Jun23Q. Contribution by discrepancies was large in this quarter.

On the supply end 

• GVA growth also stood at 7.8% yoy from 6.5% quarter before. Farm and allied sector output moderated to 3.5% from 5.5% in the Mar23Q, likely reflecting the impact of unseasonal weather and softer winter output
• Lift in manufacturing and mining activity were unable to prevent a pullback in industrial activity. Construction also slowed, notwithstanding an increase in infra and capex spending, besides slower growth in the utilities output
• Service sector added the most to the headline growth (5.6% yoy vs 3.5% in Mar23Q; change in contribution in Jun23Q vs Mar23Q +2.1pp). Support was broad-based amongst the sub-sectors - financial services and real estate (12.2% yoy) trade, hotel transport (9.2%yoy) besides public administration (7.9%)
• Core GVA (non-farm, non-government) rose a sharp 8.7% yoy suggesting relatively better faring private sector momentum
• Nominal GDP growth moderated to 8% yoy from 10.4% at the start of 2023, on lower deflators reflecting lower WPI inflation. As the chart highlights, deflators have pulled back across the different sectors, easing input price pressures

 
Outlook

Incoming high frequency numbers still suggest that domestic catalysts will continue to fare better than the external trade sector. Nonetheless, real demand could moderate on back of a surge in inflation and lagged impact of a tighter policy. Farm output is expected to reflect the impact on uneven rainfall, which could hurt kharif production. With the government expected to frontload capex in rest of first half of the fiscal year 23-24, we count on public investments to help fixed capital investments. Recurrent spending might also rise ahead of the heavy state election calendar and general elections in May 2024. 3Q23 (2QFY) growth is likely to be in the 6-6.5% range as per our latest assessment, prodding us to maintain our full-year projection at 6%, lower than the RBI’s 6.5%. Armed with a strong growth print, policymakers are expected to monitor price developments. More fiscal defence is likely to address price risks, whilst monetary policy maintains a hawkish bias to anchor inflationary expectations.


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