India is doing better than expected - provisional estimates of IIP growth for July outperformed the most optimistic forecast by around 5 percentage points. Does this mean that the expected downtrend in manufacturing growth has been negated? Not really. The HSBC Markit Purchasing Managers Index for September continues to show a cooling of manufacturing activity compared to earlier this year. We therefore still see the IIP trending down over the year, the question to answer, of course, is to what level of growth will IIP settle by March.

The high growth of 13.8% in July stems in large part from the never before seen growth of 63% in the capital goods sector. There is also the 22.1% growth in consumer durables, and vehicle production and sales continue to record highs even in September. India has actually become the seventh largest vehicle producing nation in the world in 2010, six years ahead of its target. Despite criticism of the volatility in IIP numbers, issues of accounting, obsolescence in the index etc. there is plenty of evidence from other sources that points to the high level of investment activity in the country this year. CMIE data show that 2010-11 will record the highest level of new projects commissioned, while government data on investment projects under implementation reveals a high implementation ratio of proposed projects.

Clearly, the constraints of capacity being felt by industry are being acutely felt and acted upon. Depending on how this investment pans out over the year, IIP growth in March 2011 could be anywhere between 8-11%. This is however a large range, large enough to complicate policy moves by the RBI. With growth estimates all in the range of 8-9% for this year, monetary policy has to answer questions like is the economy really over-heating, will capacity be added soon enough to relieve the pressure on supply and so on. Even if IIP numbers do not help answer such questions clearly, one fact that does stand out is that we can expect the RBI to continue the rate hike, albeit at a slow pace over the next two quarters.

Unfortunately, for the RBI, there is little support from the government when it comes to tackling the bugbear of inflation. It is true that the new series of WPI released last month gives slightly lower numbers for inflation and that both CPI IW and WPI are trending down to touch 9% and 5% levels by March. Yet, it is also true that the high inflation levels so far are now being transmitted through the system. We can blame the drought and then the flood for higher food prices, but there is little being said and done about removing the structural constraints imposed by public procurement and distribution systems that will restrain inflation to lower levels. The government of course keeps itself and its own insulated from this with DA and EPF rate hikes.

Meanwhile, as funds pour in from abroad, the stock market has been in euphoric mode and the rupee has been rising. This up trend has to level off in the months ahead as FII flows cannot be expected to continue unabated at the same rate. As usual, though this reduction is anticipated, when it comes to FIIs and the stock market, it is difficult to say when this will happen. As emerging economies around the world are putting in measures to subdue the large capital inflows, it remains to be seen how India will tackle the inflow.

All in all, though the floods will take a toll on food prices, we have had a good monsoon, though industrial output is trending down, growth is better than expected and though rate hikes will continue, the raises will be moderate. The prospects for the economy actually look brighter than they did a couple of months back.

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