Industrial production hit by the GST transition as market focuses on inventory clearance and as a result follow on orders suffer; healthy growth expected to return Q3 FY18 onwards

Impact: Negative

The industrial production has contracted by (-) 0.1% in June, 2017 as expected. The industrial production growth has decelerated from a peak of 4.4% recorded in March, 2017 to negative territory in June. In the sub-category, mining & quarrying has recorded slower growth rate of 0.4% in the month of June. On the other hand, manufacturing, which accounts for 77.6% in the overall industrial production and has recorded de-growth of (-) 0.4% during the said month after a bout of healthy growth in Q4 FY17 and much of Q1 FY18. In manufacturing, the consumer non-durable category primarily driven by pharma, FMCG and leather industry is continuing to grow at a positive rate. Going forward, a lower GST rate will further boost the growth of this segment. However, the consumer durable segment is reeling under excess inventory in the system. Perhaps the consumer durables story tells us more about the current slowdown in industrial production than any other variable given the strong consumer demand not translating into production. The largest contraction was recorded in the Electrical Goods sub category, which is reeling under pressure due to clogged supply lines/ inventories. With the GST on the anvil, for much of Q1, retailers were confused regarding the excise and other tax modalities leading to poor follow on orders.

Coming to other sectors, Construction & Infrastructure category (use based) managed to remain positive with a growth of 0.6%. Despite the growth, we expect certain tailwinds due to the implementation of RERA as well as changes in fundamental investment choices of Indians. Perhaps, the rise of DII (especially from the Mutual Fund perspective) presents a serious case demanding some considerations. Primary and Intermediate items, which rarely see a negative momentum due to the nature of the business, saw declines ranging to almost 50 bps. Moving back to Core Industries, Electricity category sowed down significantly, given severe competition from renewables to thermal power producers as well as coal supply volatility concerns. Even in renewables, reverse biddings were negatively impact given the unsustainable bid prices (per unit) being quoted over the past few months.

SMERA expected business activity to remain sluggish during the transition in the taxation system, as producers were expected to clear inventory from the system in order to align with the new tax structure. However, SMERA believes that with a smooth implementation of GST, the industrial production growth is expected to pick up pace August onwards. Rise in global inflation rate and movement in imports of the advanced economies indicate external demand will be robust in the coming months and will do the additional lift for Indian cause. This will complement the domestic demand driven by the massive government expenditure and the so far healthy monsoon. We, therefore expect a healthy growth in industrial production Q3 FY18 onwards.