The impact of demonetisation on industrial production
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Industrial production data for October 2016, the last point before demonetisation, was released last Friday. This showed that overall industrial output contracted by 1.9%. The fall over September was steeper at -6.3%. The index (IIP) has grown by -0.3% in this year so far (April-October), compared to a corresponding 4.8% growth last year. This shows how weak industrial activity was even without demonetisation, a home-grown shock. The two major components, consumer and capital goods, shed some light on trends in consumption and investment or aggregate demand. Growth in consumer goods, although positive at 1.2% in the year so far, was weaker than the last year. And capital goods output growth was -22% in the period (-26% in October) relative to a decent 9% growth in April-October 2015.
So, industry was not in a good a situation to start with. Production actually dropped in April-October across mining (-0.2% against 2.2% last year) and manufacturing (-1.0% against 5% growth in April-October 2015) with only electricity segment showing positive, 4.6% growth. If this was the state even before demonetisation, how will the industrial performance look like in coming months?
A lot worse, it seems. Consider the initial evidence from leading and anecdotal sources. November’s manufacturing PMI already showed moderation at 52.2 against 54.4 in October. Demonetisation will hurt demand with consumer goods being the worst affected. Cement sale volumes halved in November. This is unlikely to improve considering the darkened outlook for real estate—property prices are anticipated to fall by 20-40% and developers are pruning overall costs, including staff, to economize on cash and sustain bottom lines. Ripple effects will be felt in steel and other inputs as well. Automobile sales in November were 5.48% lower—the slide is expected to accelerate in coming months as sagging retail sales feed back to manufacturers who may even cut output in next round. Consumer goods’ firms whose sales volumes either fell or grew feebly in September quarter will also get impacted.
Note though that November figures will understate the impact of disturbance. Industrial performance for November, as captured by the IIP (data due in January 2017) will also not reflect the full impact of disruption. The first full impact of demonetisation on industry will thus be known only from December data, which will arrive only in February next year.
Since the cash crunch impact is widely expected to persist for two quarters, there is little chance that industrial growth will improve in the second half of 2016-17. Therefore, the year as whole may see industry contracting. This would be for the first in three years. In 2013-14, total industrial output grew -0.17% as the “taper” shock struck the economy. This time, the shock is home-grown and will impact both demand and supply sides. Whether the repercussions for industry will endure beyond the near-term is still debatable, though falling property prices and related chain effects can be long lasting.
Renu Kohli is a New Delhi based economist.