Enough has been said about the volatility of the Index of Industrial Production (IIP). What’s worrying, though, is that the poor December number appears to contradict the improvement in the manufacturing Purchasing Managers’ Index (PMI), as well as the strength in domestic demand seen in the advance estimates of gross domestic product for the current fiscal made a few days ago.
Could the difference be because PMI is an indicator of sequential growth, while IIP is a year-on-year growth estimate?
Sequentially, the IIP number was 158.7 in October, then it went up to 167.4 in November and increased further to 178.8 in December. Even the capital goods index increased sequentially in November and December.
But if the index is seasonally adjusted, a different picture emerges, though the adjustments differ. According to Nomura, sequentially, industrial production decreased by 0.9% month-on-month (m-o-m) seasonally adjusted in December, after 7.2% m-o-m seasonally adjusted growth in November.
HSBC’s Leif Eskesen writes, “In sequential terms, however, industrial production contracted by 2.2% m-o-m seasonally adjusted after expanding at a record 9.4% m-o-m (seasonally adjusted) in November.” CLSA’s Rajeev Malik says, “Sequentially, IIP declined 1% m-o-m (seasonally adjusted) in December, but this is mainly technical because of prior month’s surge of 5.8% that was partly due to the Diwali holidays.” According to Credit Suisse’s Robert Prior-Wandesforde, December output fell 1.6% on a seasonally adjusted m-o-m basis.
While the seasonally adjusted numbers vary, what’s common is that they all show a contraction in December. But that is not what the seasonally adjusted manufacturing PMI shows. The PMI output index was 55.8 in December 2011 compared with 51 in November, which indicates that output expanded at a more rapid clip in December. Prior-Wandesforde, however, says, “The best guide to the underlying trend is probably given by the three m-o-m seasonally adjusted annualized rate. This has moved up from a low of -13% in October to 3.3% in December.”
Perhaps the difference is because PMI is a survey-based measure of the top 500 companies. It’s usually the bigger firms that are able to capture the improvements in the economy first. The IIP data, however, is for the entire manufacturing sector, including a sizeable small-scale sector.
From this viewpoint PMI, therefore, serves as a leading indicator and the IIP numbers should start showing an improvement in the future.