Which indicator should policymakers trust: the Index of Industrial Production (IIP) or the HSBC Purchasing Managers’ Index (PMI)? The IIP for November was the lowest reading this fiscal year. The manufacturing PMI for November, however, showed strong expansion.
Which indicator should we believe? The two measures are, of course, different, with IIP growth usually expressed in year-on-year (y-o-y) terms, while the PMI is a seasonally adjusted month-on-month (m-o-m) indicator. It’s also a survey-based indicator, with its numbers reflecting what proportion of the companies surveyed report higher/lower output, orders, inventory, etc, rather than a measure of production volume, as the IIP is. The IIP is subject to large fluctuations, partly on account of seasonal factors such as festivals and partly on account of the volatile capital goods component. For instance, the IIP for November was affected by the Diwali holidays and by the fact that Diwali was in October in 2009. To illustrate the importance of the base effect, consider the fact that the IIP would have to grow by 9.5% m-o-m in December 2010 in order to show a 0% y-o-y growth!
The Reserve Bank of India (RBI) had, in its mid-term monetary policy statement, raised doubts about how effectively the index reflects the underlying momentum in the industrial sector. Nevertheless, manufacturing growth as measured by the IIP was 12.8% in the first quarter of FY11 and 9.7% in the second quarter. That corresponds closely to manufacturing growth of 13% in the first quarter and 9.8% in the second quarter according to the gross domestic product (GDP) numbers. However, IIP growth during the first half of the year does not show a close correlation to GDP growth. While IIP growth slowed down from 12.8% in the first quarter to 9.7% in the second quarter, GDP growth remained at 8.9% for both the quarters. The IIP numbers do not reflect the overall growth in the economy, which is what policymakers have to take into account. The PMI numbers, on the other hand, look at both services and manufacturing, not just in India but across the world.
Perhaps we should look at other numbers to clinch the argument? Unfortunately, the data have been somewhat mixed. Non-food credit growth has been accelerating. So has export growth. There has, however, been some deceleration in non-oil import growth and total imports have contracted in December. The HSBC Services PMI eased off a bit in December, but still indicates strong expansion. The Organisation for Economic Co-operation and Development’s composite leading indicator for India has remained at 100.7 (a reading above 100 denotes expansion) for four consecutive months till November 2010, showing a “stable pace of expansion”. Auto sales numbers for December have been good. Electricity generation has improved in December, but coal availability remains a problem. Taken together, the data at present seem to point towards a consolidation in growth, rather than any sharp slowdown. But perhaps the most telling response to the IIP numbers was given by the stock markets, which completely brushed off the data on Wednesday, although growth worries were evident from the pressures on the capital goods index.
What of the future? Inflation rather than growth is likely to be on top of the central bankers’ minds at the moment and there have been some calls for a 50-basis-point hike in the repo rate. This is not only because of the recent rise in food prices, but also because the PMI data for December show increased output prices. Also, commodity prices worldwide have been moving higher. RBI’s last policy statement clearly showed it is worried more about inflation than growth.
But while recent data from around the world indicate a recovery is taking place, questions remain about its strength and sustainability. Likewise, while liquidity is getting better, it remains tight, although RBI has said its stance on liquidity is separate from its monetary policy stance. Given these uncertainties, the jury remains out on whether a 25-basis-point increase rather than a 50-basis-point one will serve the central bank’s purpose on 25 January.
It’s also worth pointing out, though, that the fiscal situation next year is unlikely to be very good. The bonanza from telecom auctions will not be available, oil, food and fertilizer subsidies are likely to be higher and, if growth slows, the buoyancy in tax revenues, too, will be lower. That points to pressures on interest rates through higher government borrowing in the next fiscal year, although the government may window-dress the estimates on budget day. In the circumstances, it might be prudent for RBI to front-load its hikes, rather than go in for them when government borrowing starts anew.
To read all of Manas Chakravarty’s earlier columns, go to www.livemint.com/capitalaccount
Manas Chakravarty looks at trends and issues in the financial markets. Comment at email@example.com