INDIA

13 August 2011

Economy
Industrial production

Positive surprise hides the underlying deceleration

The positively surprising IIP growth of 8.8% in June 2011 camouflages the continued deceleration in the manufacturing sector. Core growth does not seem to higher than 5% according to our analysis. The outlook does not look promising as we expect deceleration to continue. Positive surprise in IIP growth due aberrations in capital goods; deceleration continues for most industries: IIP growth (base year 2004-05, new series) for June 2011 at 8.8% YoY was significantly higher than consensus expectation of 5.5% and our estimate of 6%. But contrastingly the old series (IIP base year 1993-94) continues to show deceleration at 4.3% YoY. The strong manufacturing sector growth at 10% YoY (new series) was primarily backed by unusual 37.7% YoY bounce in capital goods (9.3% weight in IIP). Excluding capital goods IIP (90.7% wt in IIP) growth stands at 4.1%, lower than the average of 5.7% for Apr-May 2011. Electricity grew at 7.9%, again a contrastingly strong number, compared to the 3.3% YoY contraction in domestic coal production. Bounce in manufacturing sector not broad-based: Decomposition of manufacturing sector show that 13 out of the 22 sectors (61% weight in manufacturing index) decelerated out of which 10 (38% weight) grew less than 5% YoY. The unusual bounce in Electrical machinery and apparatus at 88.9% YoY seem to have skewed the overall manufacturing sector growth. Other sectors that contributed to the bounce include office accounting & computing machinery (19% YoY) and other transport equipment (18.6%YoY). Components behind capital goods bounce are unusual: Some of the important items of capital goods have shown unusually high growth viz. cable and insulated rubber (232.4% YoY), printing machinery (81.1% YoY) and rubber transmission & V belts (57% YoY), respectively. In our earlier analysis, we have observed similar aberration in insulated cables last year (old series) and it seems to have continued in 2011 as well. Quarterly results of capital goods companies do not corroborate the robustness shown in the IIP. In addition, new projects announced in Q1FY11 registered a steep 60% YoY contraction. Sharp deceleration in consumer goods: Contrasting the 37.7%YoY surge in capital goods is the sharp deceleration in consumer goods which grew by just 1.6% YoY. Importantly, this deceleration is contributed by both durables (1%) and non-durables (2.1%). The slowdown in durables is significantly higher (3.3% YTD in FY11 vs 19.7% last year). A strong 7.5% YoY in basic goods (3.7% Jun 2010) is contributed by basic metals and fabricated metal products and is in-line with the 12.5%YoY growth in steel production for the month. The post-2008 crisis rebound lacked pervasiveness and endurance: Manufacturing sector growth (new series) excluding the high volatile components of the manufacturing sector (coefficient of variance > 20% and 69% weight) have averaged 4.1% since Apr 2009 vs. 10.7% during FY06-08. This confirms our earlier analysis. Accordingly, the Big Four in the manufacturing sector (old series) comprising metal products, machinery, transport equipment and other manufacturing, weighing 24% in the manufacturing index (old series), grew 8.6% YoY in June vs 4.1% in May 2011. However, other sectors weighing 76% in the manufacturing index slowed to 2.1% in June after a modest 5.5% growth in FY11. Outlook: Overall sense emerging from the IIP data suggests that the underlying growth, excluding volatile components, is not more than 5% in June and growth continues to decelerate. High input costs, rising lending rates and worsening financial conditions are likely to weigh on the outlook. Sustained weakness in investments is getting aggravated by the sharp deceleration in consumption. Weakening global economy pose additional threats to sustaining growth. However, the quality of data continues to be suspect not just with regards to IIP but also relating exports figures. The 82% YoY growth in exports in July 2011, following a 46% YoY average growth during Apr-June 2011 is completely out of sync with cargo data from major ports. Growth deceleration and high inflation is a big challenge for the RBI: With growth slowdown getting widespread, there is convincing evidence of demand deceleration. However, despite all the efforts made by the RBI, inflation continues to remain high (over 9.4%). Transaction demand for money is contracting (-13% YoY) and credit growth is fast decelerating (18.5% YoY in July 2011 vs. the recent peak of 25%). Clearly, this combination will be a big challenge for the RBI. While we maintain our view that rate hikes will increase the possibility of hard-landing, especially in the current situation of global slowdown, one will need to see if the RBI tones down its hawkish stance or not.

Dhananjay Sinha dhananjay.sinha@centrum.co.in +91 22 4215 9619

Please refer to important disclosures/disclaimers in Appendix A

Centrum Equity Research is available on Bloomberg, Thomson Reuters and FactSet

Exhibit 1: IIP growth summary (Base year 2004-05)

YoY (%) Wt in IIP (%) Jun-10 Sectoral Mining Manufacturing Electricity User Based Basic goods Capital goods Intermediate Consumer goods Durable Non-durable General Source: CSO, Centrum Research 35.6 9.3 26.5 28.6 5.4 23.2 100.0 3.8 3.7 8.6 13.3 21.3 7.5 7.5 7.5 37.7 1.8 1.6 1.0 2.1 8.7 5.5 17.2 10.7 11.5 19.7 5.4 9.6 7.2 16.8 2.2 4.2 3.3 4.9 6.8 10.5 79.4 10.2 7.0 7.9 3.6 0.6 10.0 7.9 8.0 10.4 5.4 1.1 7.5 8.2 Jun-11 YTD FY11 FY12

Exhibit 2: IIP growth summary (Base year 1993-94)

YoY (%) Wt in IIP (%) Sectoral Mining Manufacturing Electricity User Based Basic goods Capital goods Intermediate Consumer goods Durable Non-durable General 35.5 9.7 26.4 28.4 5.1 23.2 100.0 3.3 7.5 9.7 8.6 26.5 2.0 7.2 7.3 7.5 (1.0) 4.7 10.5 2.0 4.3 6.8 32.0 10.5 9.2 27.3 2.6 11.9 6.5 3.1 0.7 5.2 9.1 3.4 4.0 14.2 75.5 10.3 8.8 7.4 3.5 (0.9) 4.4 8.0 10.2 12.6 5.6 0.7 3.9 8.2 Jun-10 Jun-11 YTD FY11 FY12

Exhibit 3: IIP (% YoY) - New vs. old series

25 20 15 10 5 0 (5) (10) Jun06 Jun07 Jun08 Jun09 Jun10 Oct06 Oct07 Oct08 Oct09 Feb07 Feb08 Feb09 Feb10 Oct10 Feb11 Jun11

Exhibit 4: IIP growth (% YoY)- Considerable up-scaling in FY07-08; Recovery in FY09-FY11 has remained sub-par
18 16 14 12 10 8 6 4 2 0 FY07 FY08 FY09 FY10 FY11
IIP 2004-05

15.5 12.9 11.9 10.5 7.7 5.3 4.2 2.5

Sharper drop in growth in new IIP series 14.2 9.8 7.8 8.2 7.5 5.3

Avg FY07FY08

Avg FY09FY11

IIP 2004-05

IIP 1993-94

IIP 1993-94

Source: CSO, Centrum Research

Source: CSO, Centrum Research

Exhibit 5: IIP (SA Log scale): Flatter new trend line

2.30 2.25 2.20 2.15 2.10 2.05 2.00 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11
Source: CSO, Centrum Research

Old trend line (May 2005-Feb 2008: 14.3% annual growth

Downward shift

New trend line (Aug 2009-Jun 2011: 6.7% annual growth

Economy

Exhibit 6: IIP (SA) sequential rise

180 176.8 175 172.1 170 165 160 155 150 145 Sep-10 May-10 Apr-11 Jan-11 May-11 Jun-10 Dec-10 Aug-10 Nov-10 Mar-11 Feb-11 Jun-11 Oct-10 Jul-10 168.7 168.7

Exhibit 7: IIP (SA) MoM growth

5 4 3 2 1 0 (1) (2) (3) (4) Aug-10 Nov-10 Apr-11 May-10 May-11
Dec-10
Jun-10

3.3 2.0 0.5 2.5 1.0 0.1

3.7 2.0

(0.5) (2.0)

(0.9)

(0.8) (1.5) (3.2) Dec-10 Feb-11 Mar-11 Sep-10 Oct-10 Jan-11

2004-05 series Source: CSO, Centrum Research

2005-05 series Source: CSO, Centrum Research

Exhibit 8: IIP & core sector growth( % YoY)

25 20 15 10 5 0 (5) (10) Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Jun-11 14 12 10 8 6 4 2 0 -2

Exhibit 9: Credit and IIP growth

40 30

30

Jun-10

20

10

0 Dec-06 Dec-07 Dec-08 Dec-09 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11
Dec-10

IIP growth (%YoY)

Core sector growth (% YoY)

Credit growth

IIP growth (RHS)

2004-05 series Source: CSO, Centrum Research

2004-05 series Source: CSO, Centrum Research

Exhibit 10: Manufacturing: Big 4 rose to 8.6% YoY in Jun 2011, rest others weighing 76% grew at 2.1%
50 40 30 20 10 Growth slowdown since Dec 2009

20 15 10 5

Rest others

0 (10) Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11

0 (5) Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-11

Big 4s

Rest others

All manufacturing

Big 4s (24% wt in manufacturing) incl Metalpdts, Machinery, Transport & parts & Other manufacturing; Rest others incl the balance 13 sectors (wt 76%); 1993-94 series Source: CSO, Centrum Research

Economy

Jun-11
20 10 0 (10)

Jul-10

Exhibit 11: Manufacturing (New series): The lack of broad based recovery confirmed even by the new series, average growth for 70% of manufacturing sector averaged just 4.1% since Apr 2009, 5,5% in Jun 2011
30 25 20 15 10 5 0 (5) (10) (15) Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Sep-06 Sep-07 Sep-08 Sep-09 Mar-07 Mar-08 Mar-09 Mar-10 Sep-10 Mar-11 Jun-11
Jun-10

Manufacturing sector (low vol components, 69% wt)

Manufacturing sector

We estimate non-volatile index (base year 2004-2005) by excluding high volatility sectors (coefficient of variance greater than 20%) such as food products and beverages(28%), fabricated metal products (23%), Machinery and equipments(29%), office accounting and computer machinery ( 26%) , Electrical machinery ( 53%), Radio, TV communication (49%), Motor vehicle (29%) and other transport equipments( 25%) respectively. Source: CSO, Centrum Research

Exhibit 12: IIP and IIP excluding capital goods moves Exhibit 13: IIP and IIP excluding capital goods; correlation is closely together; correlation is 99% during May 05 to June 11 91% during May 05 to June 11
(YoY %) 25 20 15 10 5 0 (5) (10) Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Sep-06 Sep-07 Sep-08 Sep-09 Mar-07 Mar-08 Mar-09 Mar-10 Sep-10 Mar-11 Jun-11

(YoY %) 20 15 10 5 0 (5) Jun-09 Aug-09 Aug-10 Feb-09 Feb-10 Feb-11 Apr-09 Apr-10 Dec-08 Dec-09 Dec-10 Apr-11 Jun-11 Oct-09 Oct-10

IIP_2004-05

IIP excluding Capital goods

IIP 1993-94

IIP excluding capital goods

2004-05 series Source: CSO, Centrum Research

1993-94 series Source: CSO, Centrum Research

Economy

Exhibit 14: Sectors IIP growth (YoY %)- 2 digit classification (Base year 1993-94)
YoY % Sector and user based performance Manufacturing products Food Beverages, Tobacco etc Cotton Textiles Wool, Silk and man-made fibre textiles Jute and other vegetable fibre Textiles Textile Products Wood/wood products; Furniture etc Paper & paper products and publishing & allied Leather and leather products Basic chemicals & chemical (ex petroleum & coal) Rubber, plastic, petroleum and coal Non-metallic mineral Basic metal and alloys Metal products/parts (ex machinery & equipment) Machinery & equipment (ex transport) Transport equipment & parts Other manufacturing Manufacturing Mining Electricity General User Based Basic goods Capital goods Intermediate goods Consumer goods Durables Non-durables Source: CSO, Centrum Research Weight (%) 9.1 2.4 5.5 2.3 0.6 2.5 2.7 2.7 1.1 14.0 5.7 4.4 7.5 2.8 9.6 4.0 2.6 75.5 14.2 10.3 100.0 35.5 9.7 26.4 28.4 5.1 23.2 Jun-10 8.6 0.2 8.8 (2.7) 30.1 2.3 (7.0) 3.3 (10.4) 5.1 13.4 5.3 (0.4) 69.6 3.4 25.7 21.0 7.4 8.8 3.5 7.2 3.3 7.5 9.7 8.6 26.5 2.0 Jun-11 18.7 6.3 (11.2) 0.3 (1.9) (18.9) (84.9) 4.3 2.8 (4.2) 13.8 5.8 17.0 (3.4) 5.6 15.5 18.8 4.4 (0.8) 8.0 4.3 7.3 7.5 (1.0) 4.7 10.5 2.0 YTD (YoY %) FY11 13.7 (4.3) 7.7 (2.2) 17.1 1.2 (9.2) 6.5 0.6 7.2 16.0 6.2 6.4 46.1 23.1 29.6 28.0 12.6 10.2 5.6 11.9 6.8 32.0 10.5 9.2 27.3 2.6 FY12 22.8 8.3 (7.4) (6.7) (16.3) (21.8) (70.9) 4.7 3.0 (1.9) 11.5 3.1 12.7 2.6 0.0 17.1 24.7 3.9 0.7 8.2 4.0 6.5 3.1 0.7 5.2 9.1 3.4

Economy

Exhibit 15: Sectors IIP growth (YoY %)- 2 digit classification (Base year 2004-05)
YoY % Sector and user based performance Manufacturing products Food products and beverages Tobacco products Textiles Wearing apparel; dressing and dyeing of fur Luggage, handbags, saddlery, harness & footwear; tanning and dressing of leather products Wood and products of wood & cork except furniture; articles of straw & plating materials Paper and paper products Publishing, printing & reproduction of recorded media Coke, refined petroleum products & nuclear fuel Chemicals and chemical products Rubber and plastics products Other non-metallic mineral products Basic metals Fabricated metal products, except machinery & equipment Machinery and equipment n.e.c. Office, accounting & computing machinery Electrical machinery & apparatus Radio, TV and communication equipment & apparatus Medical, precision & optical instruments, watches and clocks Motor vehicles, trailers & semi-trailers Other transport equipment Furniture; manufacturing n.e.c. Manufacturing Mining Electricity General User Based Basic goods Capital goods Intermediate goods Consumer goods Durables Non-durables Source: CSO, Centrum Research 35.6 9.3 26.5 28.6 5.4 23.2 3.8 3.7 8.6 13.3 21.3 7.5 7.5 37.7 1.8 1.6 1.0 2.1 5.5 17.2 10.7 11.5 19.7 5.4 7.2 16.8 2.2 4.2 3.3 4.9 7.3 1.6 6.2 2.8 0.6 1.1 1.0 1.1 6.7 10.1 2.0 4.3 11.3 3.1 3.8 0.3 2.0 1.0 0.6 4.1 1.8 3.0 79.4 10.5 10.2 100.0 16.4 29.8 4.4 8.5 (7.2) (6.6) 4.2 8.9 2.2 1.1 13.9 4.0 1.3 13.8 29.9 (9.3) (23.0) 30.0 30.0 39.3 27.1 (9.8) 7.9 7.0 3.6 7.5 6.7 9.6 (4.3) (5.5) 15.7 (0.3) 6.2 11.1 4.2 (1.0) (0.3) 3.2 17.7 12.0 2.2 19.1 88.9 (10.1) (10.3) 14.5 18.6 10.3 10.0 0.6 7.9 8.7 15.9 9.5 4.8 4.0 7.5 9.3 3.8 10.5 2.4 (1.5) 18.9 6.8 3.4 15.1 38.0 (10.0) (0.4) 19.5 18.4 42.3 30.5 (1.9) 10.4 8.0 5.4 9.6 11.8 3.6 (4.3) 0.1 4.9 (7.6) 8.1 10.9 6.0 3.7 (2.1) 0.5 14.8 14.9 (1.6) 29.6 24.1 (3.5) 8.4 20.2 19.0 0.1 7.5 1.1 8.2 6.8 Weight (%) Jun-10 Jun-11

YTD (YoY %)
FY11 FY12

Economy

Appendix A
Disclaimer
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Economy

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Economy