No real turnaround in sight for India yet By SONAL VARMA, ECONOMIST, NOMURA INDIA India's IP contracted by a sharper-than-expected 1.8 per cent year-on-year in June after growth of 2.5 per cent year-on-year in May. Apart from adverse base effects (IP rose 9.5 per cent last June), a sharp contraction in capital goods output growth (-27.9 per cent) was mainly responsible. The deepening slump in capital goods production suggests that investment activity is worsening. In addition, consumer non-durables output growth contracted 1 per cent year-on-year from an already subdued 1.3 per cent in May, suggesting high inflation may have reduced demand for non-discretionary consumption as well. Production of consumer durables picked up in June (+9.1 per cent year-on-year), but sustaining this may be difficult given higher inventories with auto dealers. Meanwhile, the sharp contraction in manufacturing output growth was led by electrical machinery, motor vehicles, food and beverages and textile segments. IP growth averaged -0.2 per cent in Q2 versus 0.6 per cent in Q1, lower than our estimates. However, this has been offset by higher-than-expected government spending. As such, we maintain our Q2 GDP growth estimate of 5.4 per cent year-on-year (Q1 was 5.3 per cent). Going forward, base effects should push y-o-y IP growth back into positive territory, but deficient monsoons, the fall in the exports new orders index, a contraction in non-oil imports and government inaction suggest that the underlying momentum remains weak. Both domestic and external demand components of the manufacturing PMI weakened in July. Plus, the OECD's composite leading index suggests that a real turnaround is not yet in sight. Notably, July IP growth is likely to be weak as production suffered due to a shutdown in auto companies and the power blackout. While sustained weakening in IP growth calls for policy easing, we expect WPI inflation to rise to 7.5 per cent year-on-year in July from 7.2 per cent in June and core WPI (non-food manufactured) inflation to inch above 5 per cent (from 4.8 per cent). Moreover, rising food price inflation and an impending fuel price hike should push headline WPI inflation above 8 per cent by Q4 of 2012. As such, we expect policy rates to remain on hold in 2012 with a 50 basis point rate cut in the first half of 2013.