There is a distinct chill coming through from the RBI to the government– rates will not be cut unless the government shows a credible path on fiscal consolidation. The message was strong and clear in the policy review last week and given that the likelihood of the government paying heed is low, expectations are now muted on rate cuts. Rate cuts will therefore be slow over the year ahead, with a sharp focus on inflation in manufactured products. What lies ahead for manufactured products? Inflation here is falling very slowly and is expected to stay in the 6-7% range for the next two quarters. There are many underlying forces keeping the trend from declining further. Even while inflation in primary food products has fallen sharply last month, the RBI reiterated what we have been saying, pressures persist. The HSCB Markit PMI for January already shows strong input price inflation in the manufacturing sector with high raw material costs. Going ahead, we have already identified oilseeds as one pressure point that has now materialised in the official WPI. Sugar is another one lurking in the background now, though levels are currently low, domestic levy has been increased and given the drought in South America lowered output from Brazil can push prices up further in another few months. For fuel, while the geo-political situation clearly is one that can yield to short term spikes, according to the EIA forecasts higher prices will continue on an average through 2013. Further, the upside risk to global commodity prices mentioned by the RBI has already materialised with the Fed pledging a loose policy for another two years. Net net, inflation is not going to let up so easily.

There is one more rough spot ahead, one that is typically not monitored as zealously as the WPI. We note that hiring in real estate and construction has been and is expected to be one of the strongest amongst all the sectors in this quarter, at the same time, Eyestate, the real estate database by Indicus Analytics and Knight Frank shows that despite almost half the ‘affordable’ houses remaining unsold, there is no discernible trend towards price correction. Putting these two facts together, are we heading for a bubble here? The strong pricing power that the RBI policy review has also referred to in this sector is another factor that will keep the central bank from rapid rate cuts this year.

So what is the good news? Fortunately, the fact that the rate cycle has clearly peaked is enough to provide the much needed relief to firms and consumers. The MSME Business Confidence Survey conducted by Indicus in December showed that investment and expansion plans for the current quarter were higher than before for some sectors like textiles, garments and leather and intent had been maintained at levels higher than reported in June for sectors like the services sector, chemicals and pharmaceuticals, processed food. The question is what impact would this have on growth next year? It is clear now that the manufacturing sector is not looking as bleak as it did a couple of months ago and though the IIP will continue its volatile trajectory through the next two quarters, the general trend will be upwards into a 7% growth average by June. The PMI for manufacturing in January rose dramatically over the previous month, with the ‘strongest expansion in business conditions since May’. Rail freight data also show a higher growth in cargo movement in the last two months of 2011, supporting the rebound in industrial activity. Looking at hiring trends, we have also seen that hospitality, education and trade are the three sectors that have hired significantly more than they expected last quarter, pointing to the fact that the services sector has held up very well. With some movement coming in on the policy front with FDI in retail, the trade, hotels, restaurants, transport and storage sector can be expected to do even better next year. Though agricultural prospects will continue to remain dependent on the rains, with momentum in growth returning across all other sectors, we can now comfortably look forward to an economy that grows at 7.5% next year. It’s as good as it can get.