Thursday, September 13, 2012

IIP, Exports and Bank Credit Numbers Bad? No, Not At All

Over the last two days the numbers for the Index of Industrial Production (IIP), exports and bank credit were reported and, on the face of it, they look disappointing. However, a deeper look shows the long-term growth trend is intact and, in fact, all the key indicators point to the possibility that the growth slowdown is also over and the economy is getting ready for the next growth phase.

To understand this better we need to look at the economic and market recovery during 2009 after the great bear market of 2008. During that time, equity markets started to make new intermediate highs in the April-June 2009 period in anticipation of the upcoming growth phase later in the year (which did materialize). These intermediate highs were accompanied with huge increases in foreign institutional investor (FII) inflows, even as IIP, bank credit and exports were tracing negative year-over-year (YoY) growth numbers.

Refer to my analysis of December 2011 (Macro-Technicals Point to a Possible Bottom) in which I talked about a possible bottom and the indicators for the same. My analysis shows that an economic recovery is preceded by falling inflation and a rise in commodity prices after making new lows as well as a rise in U.S. 10-year yields after making new lows. And that equity markets would continue to make new intermediate highs even as IIP and exports trace negative YoY growth numbers and bank credit YoY growth continues to fall.

It is exactly the same recovery pattern that is being traced out now, with equity markets making new intermediate highs, a sharp increase in FII flows, falling wholesale inflation, a rise in commodity prices after new lows and a rise in U.S. 10-year yields after making major lows.

In fact, the growth numbers for IIP, exports and bank credit being posted now are far better than during the economic and market recovery of 2009. For instance, exports are down 9.7% now compared to the minus 35% during the market recovery of 2009. As for bank credit growth, it is at 17% now compared to 15% during the 2009 recovery. In fact, bank credit growth went down to 10% later in 2009 even as equity markets continued to make new intermediate highs. As for IIP, it is running at around 1% now compared to minus 2% during 2009.

The only cause for a concern is a fall in corporate profitability in the June 2012 quarter after tracing a recovery pattern in prior quarters. Overall economic recovery is typically preceded by a slight improvement in corporate profitability numbers and hence the concern. The silver lining here is that most key sectors – including banking, software and consumer goods – showed a rising profitability trend with overall corporate performance numbers being pulled down by infrastructure-related industries, primarily energy and steel. Keep in mind though that infrastructure sectors typically start to recover only when recoveries in the banking and consumer sectors are well-established. The extraordinarily poor numbers in energy and steel were driven by environmental regulatory issues and the banning of iron ore mining in certain states. With the ban already lifted in Karnataka, I believe these issues are transitory and the worst case is that the beginning of the next growth phase might get pushed back by a quarter or two.

In conclusion, there is no cause for concern around the recently released numbers for IIP, exports and bank credit even though on the surface they might sound disappointing. Most of the economy- and market-related indicators are pointing toward the economic recovery picking up pace and the equity markets continuing to make new intermediate highs.