On the face of it, the number does look very good. More importantly, this is the first double digit growth. The index, which virtually stagnated since August 2008, has picked up some pace since June. And now a double digit jump. Not surprisingly the market also responded positively.
However, a few words of caution are in the offing.
· The August growth rate has the base effect to thank for, for being able to grow so fast. The index value in August 2008 was lower by nearly 2.5% as compared to July 2008
· While the growth of capital goods bodes well, it needs to be remembered that the capital goods index (at 402.7) is still 8.5% lower than that of June index value (at 437.8). It is up month on month from July
· Continuous contraction of non-oil imports also does not bode well for the capital goods sector
· With domestic demand not picking up as much, higher level of activity points toward increased inventory built-up
· With agriculture being very badly hit because of drought in many areas and a combination of drought & flood is some others, 60% of India’s (the approximate size of India’s rural population) domestic demand will be badly hit going forward. More so as the positive effect of government spending in rural sector wanes off
· Clear slowdown in credit demand also does not bode well for the economy. While Reduced CRR and increased deposit does indicate availability of enough liquidity, much lower amount is flowing into the real economy. This is evident from clear slowdown in non-food credit and declining Credit to Deposit Ratio. Clearly the bullishness of the stock market is not in sync with the subdued outlook of business investment
I continue to be cautious on the outlook for the next couple of quarters. With the market being flush with liquidity and more likely to flow from afar, negative news is not being discounted to the extent that should have been while positive news is being lapped up like there’s no tomorrow. Indeed it is a classic case of markets being overheated.