The level of capacity utilization is an important indicator of demand pressures in the economy. When demand is high, capacity utilization goes up. If capacity utilization is very high and the central bank eases monetary policy to increase demand, prices will go up simply because, in the short-run, firms will not be able to expand capacity and increase supply.
What is the state of capacity utilization among firms in India? The Reserve Bank of India’s (RBI) quarterly order books, inventories and capacity utilization survey provide some clues. The survey is for the third quarter of 2011-12. The accompanying chart shows the results. Although capacity utilization increased compared with the second quarter of 2011-12, it was at the same level as in the year-ago period. It was also well below the level reached in the third quarter of 2009-10. RBI’s quarterly industrial outlook survey for January-March 2012 provides further data. In its assessment of production capacity with regard to expected demand in the next six months, 82% of those surveyed said capacity was adequate for the April to June 2012 quarter and only 6.7% said capacity was less than adequate. That was lower than the 7.2% who said capacity was less than adequate to meet demand in January-March 2011 and the 8.5% who said it was less than adequate for October-December 2011. Clearly, the percentage of firms that believe capacity is adequate and more than adequate to meet demand is increasing.
In short, if the RBI surveys on capacity utilization are correct, then there’s adequate spare capacity in the manufacturing sector and core inflation should be contained.
Graphic by Paras Jain/ Mint
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