We think incoming data should support our call that while the worst is over, it will not be till early 2013 that recovery will begin. July industrial growth should report another abysmally weak 0 per cent, atop June’s (-)1.8 per cent drop, on September 12.

August inflation will likely post a relatively high 7 per cent, on drought-driven agflation, on September 14. With growth set to slow below the RBI's 6.5 per cent FY13 forecast, we expect it to cut CRR by 25bp on September 17.

After all, unless lending rates come off, FY13 growth will find it difficult to notch even our modest 5.6 per cent. We do appreciate that Gov Subbarao may not want to cut policy rates at 7 per cent inflation as he would not like to take chances with the RBI’s inflation fighting credentials.

No matter! In any case, in our view RBI policy rate cuts are unlikely to transmit into bank lending rate cuts until M3 growth normalizes to, say, 16 per cent from the current way-too-tight 13.7 per cent. There is some talk in Delhi about announcing a policy package – including an oil price hike and some ‘reform’ measures – next week but let us see what finally gets done.

We expect July industrial growth to report another abysmally weak 0 per cent, atop
June’s 1.8 per cent contraction, with high lending rates hurting demand. After
all, India is the only BRIC to hold lending rates at their 2008 peak.

The end-July power grid failure could also hurt industrial production numbers. Infrastructure industries (37.9 per cent of IIP) have already slowed to 1.8 per cent from 3.9 per cent in June.

The HSBC Markit manufacturing PMI has also come off to 52.8 in August and 52.9 in July – although it remains in 50+ expansionary zone. For details, do read our last lead indicator report here.

We expect August WPI inflation to come in at a relatively high 7 per cent, atop July’s
6.9 per cent, on September 14, on drought-led agflation. Had Delhi hiked oil prices by our expected 10 per cent, inflation would have been higher at an estimated 7.8 per cent.

At the same time, core inflation should persist at relatively benign 5 per cent levels with RBI tightening killing corporate pricing power. At the same time, core inflation will likely rise for the next few months on base effects.

Drought has been naturally pushing up agflation in recent months. A 5 per cent swing in agro prices impacts inflation by 150+bp. At the same time, the recent revival of rains should cool down agflation faster than earlier anticipated.

After all, the rainfall deficit has come down to 12 per cent from 17 per cent a month ago. In particular, the smart pickup in pulses sowing should contain pulses price inflation ahead.

Just as importantly, the improvement in rainfall should protect the winter rabi crop
from drought. This should support our call of inflation cooling off in the March quarter to 7.3 per cent, inclusive of a 10 per cent hike in oil prices.

The revival in rainfall has pushed up Indus waters, a good proxy for moisture conditions in north-west Indian wheat fields, to a deficit of 9.8 per cent of average from 27.1 per cent of average last week. This has pushed up water storage levels at the Bhakra, Pong and Thien dams that irrigate north-Indian wheat fields, to 90 per cent of average. Do read our last monsoon report here.

We expect a 25bp CRR cut in the September 17 monetary policy to cut lending rates with growth set to slow below the RBI's 6.5 per cent and the PM's Economic Advisory Council's 6.7 per cent forecasts. Unless lending rates come off by, say, 100bp (25-50bp done), FY13 growth may find it difficult to achieve even our modest 5.6 per cent. Indeed, India is the only BRIC in which lending rates are stuck at peak 2008 cycle levels. For details, do read our last lending rate report here.

We do appreciate that Subbarao may not want to cut policy rates at 7 per cent inflation as he would not like to take chances with the RBI’s inflation fighting credentials. No matter! In any case, in our view, RBI rate cuts will not likely transmit into lending rate cuts until M3 growth normalizes to 16 per cent from the current way-too-tight 13.7 per cent.

We expect the RBI to commence OMO by end-September given that its US$14 billion of FX forwards contracted have effectively neutralized the Rs 81,500 crore of OMO conducted so far. With permanent primary liquidity injection again beginning to dwindle like early 2012, deposit growth is getting stuck at way-too-low 14 per cent levels.

Although loan demand is softening to 16 per cent levels on high lending rates, lending rates themselves are not easing commensurately as a tight RBI policy is restricting deposit creation.

Would lending rates cuts be enough, clients often ask, if investment does not recover? We expect lending rate cuts to revive investment as Econ 101 teaches us. Not surprisingly, Chart 7 shows that it was the drop in lending rates, on sustained RBI easing after the dotcom bust, that led to the subsequent jump in investment.

Even now, SBI Pratip Chaudhuri has told the media that loan demand is picking up in segments where his bank has cut lending rates.