Manufacturing PMI grows strongly despite headwinds

The HSBC Purchasing Managers’ Index (PMI) for the manufacturing sector for January has been a strong 57.5 and most of the sub-indices, including the New Orders index and the Export Orders index, are well above long-term averages. As we said at the time the December PMIs came out, a bottom seems to have been formed in the economy around the end of last year and it has improved in the past couple of months.

There are a few other positive data points. One, non-oil import growth was up 23.4% year-on-year (y-o-y) in December. That’s better than November’s 21.7% growth, as also October’s 22.1%. And it’s well above September 2011’s y-o-y non-oil imports growth of 18.2%. True, non-oil imports include gold imports, and, therefore, the data needs to be treated with caution, but if gold imports are not increasing, higher non-oil imports are an indication of strength in the economy.

Let’s not read too much into the PMI numbers, which are based on surveys of the largest companies. Reserve Bank of India (RBI) data show that this fiscal, growth in bank credit for the large companies has been 17.1% till the end of December, while it was 19.5% over the same period last fiscal. The real deceleration in loan growth has been to medium-sized companies, where growth in bank credit has been 7.6% this fiscal till end-December, compared with 19.3% over the same period last fiscal. The growth in lending to small companies, too, has been much lower in the current fiscal, as have loans to the services sector. It’s possible that the PMI is not really representative of the entire economy.

The other factor that needs to be considered is that while companies’ revenues have seen good growth, it’s not true of net profits. The Capital Market survey referred to above shows net profit of the 1,088 companies contracted by 1.7%. Losses due to margin compression, due to rupee depreciation and, for banks, higher loan loss provisions, have taken their toll on profits. So the growth in revenue is not mirrored by growth in corporate earnings.

The upbeat PMI data comes in the midst of downward revisions to India’s GDP growth by the World Bank, the United Nations and the International Monetary Fund. The outlook for investment demand continues to be gloomy, oil prices remain high and it’s unlikely that RBI will cut rates in a hurry. The manufacturing PMI for January shows the output price sub-index at 56.1, at around the same level as in December and indicating that companies still enjoy pricing power. The input price sub-index is even higher at 63.4. This difference in these two indices shows the pressure on margins. But with manufacturers still passing on at least part of their input price increases and growth strong, the PMI numbers will not comfort anyone looking for an early rate cut by the central bank.

Do the strong PMI numbers reflect the continuing strength of consumption demand? It’s likely they do. But there’s another factor—the continuing high level of government expenditure. The latest data on the fiscal deficit show that over the period April-December, total central government expenditure went up 13.9% year-on-year, despite a 16.3% contraction in total receipts. The bloated fiscal deficit is holding up growth.

Interestingly though, government spending is not just boosting consumption. During April-December, y-o-y growth in revenue expenditure was 12%, while growth in capital expenditure was 29.5%, of course on a far smaller base. So while it’s true that investment demand is sluggish, the government is doing its bit to boost it.

But if the Indian economy has bounced off a bottom, what are the factors that could have caused it? There could be several reasons: one, the realisation the bottom is not going to drop out of Europe tomorrow; two, the realisation that consumption demand continues to be strong in India—the PMI shows businesses are re-stocking, seen from a rise in the index of the stock of finished goods; three, reassurance from RBI the bottom of the interest rate cycle has been reached and four, improved sentiments in the stock market as a result of the revival of inflows by foreign institutional investors.

But consumption demand can only go so far and no further. Indeed, too strong a growth in consumption demand will only delay RBI’s rate cuts. What is needed to boost growth is the revival of investment demand. For that to happen, as the RBI monetary policy statement said, the deficit has to be curtailed and government expenditure has to lower consumption and boost investment. Policy initiatives also have to be taken. At the moment, that looks to be a very tall order.

Manas Chakravarty looks at trends and issues in the financial markets. Comments are welcome at capitalaccount@livemint.com

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