Graphic: Ajay Negi/Mint
Graphic: Ajay Negi/Mint

IIP might be better than reported

The reported negative growth in capital goods segment is a distortion being magnified by one particular industry

A key source of concern regarding economic revival in India has been that the growth of the main indicator of manufacturing activity, the Index of Industrial Production (IIP), has remained very weak and fairly erratic. This, in large part, is due to the capital goods segment, which has remained deeply negative since November 2015, at -12% for the last reported month of May 2016, and an average -18% over November 2015-May 2016. Capital goods comprise 8.8% of the IIP. The capital goods sector has, for good reason, been considered probably the most important missing engine of growth. The worry is compounded by the lack of response of the segment to the accelerated government spending in key infrastructure segments such as roads, electricity transmission, railways and urban infrastructure.

It turns out that for the past few months, growth of the capital goods has actually been much better than reported. The base year for the current IIP series is 2004-05 and comprises a basket of industries which expert committees involved in the construction had deemed representative of the structure of manufacturing then prevalent. One component of capital goods, which has persistently drawn attention over the past couple of years, has been “cables, rubber insulated". On closer examination, it turns out that the reported deep negative growth of the capital goods segment is a distortion being magnified inter alia by this particular industry.

“Cables, rubber insulated" are cables used by telecom companies. When the present 2004-05 IIP series was constructed, this industry was represented by a handful of companies. The methodology of computation of the IIP, based upon a fixed sample panel of companies, requires that the same companies in the panel report their output, month after month, to the Central Statistical Office. This industry is disproportionately represented by one major company which supplies primarily to one large public sector telecom services provider. The reported production of this industry changes with production by this specific company which in turn depends on procurement by the aforementioned services company, whose requirement varies across months, with very large fluctuations. It is also likely that the service provider has started sourcing from other companies, leading to a significant reduction in production in the reporting company in recent months.

The chart shows the magnitudes of (albeit intermittent) deviations of the reported capital goods and our synthetic series constructed by excluding the data pertaining to rubber cables. We need to emphasize that, barring a few months in the long series we have computed, particularly for the past few months, there is an element of approximation. The inability to get a more comprehensive picture of the IIP is compounded by the decision to stop releasing a detailed list of 227 constituent industries in December 2013 (which had been available since April 2009). The IIP data release nowadays is accompanied by a statement which lists the top few growth segments and the top de-growth (negative) industries, together with their contributions to the IIP growth. As can be expected, other than a few industries, the list is not uniform, and it is difficult to construct a comprehensive series of select industries. The IIP series is updated at least thrice, but there is no way which we can factor in those upgrades.

With this caveat, the following are the trends in the capital goods segment and the constituent “rubber cables" industry. The chart shows that for much of FY15 and part of FY16, the two series were co-moving, with minimal average deviation. But there emerges a sharp fissure since November 2015. Rubber cable actually has a relatively low weight in the IIP (0.12%, with the capital goods weight of 8.8% as reference). However, the growth (or de-growth) magnitudes are very large. For instance, rubber cable de-grew by 90% year-on-year in May 2016 (with an average de-growth of -88% over November to May). This is also the case with a couple of other industries in the capital goods segment, although the effects are much more muted.

The synthetic index series of capital goods (excluding rubber cables) grew at an average rate of 5.2% over November 2015-May 2016, and at an average 8% during April-May 2016, exactly the same as the average during the corresponding two months of FY16. On the other hand, the unadjusted (reported) capital goods growth was an average 4% and -19% during April-May FY16 and FY17, respectively. For the full IIP, the growth improves from the reported -0.5% over the past seven months to an adjusted 2.3%.

What can now be done about this anomaly, which is likely to continue for some time? The Central Statistical Organisation (CSO) will be releasing a new 2011-12 base IIP series later in 2016. In this new series, we are told, every industry will have around eight companies in the sample, in order to reduce the distortions via concentration effects, induced by a particular company with a disproportionately large weight. However, till then, the existing panel of companies will continue, and if CSO provides the partial details of the industries with the maximum movements, we can attempt to derive a truer picture of the capital goods segment.

The bottom line is that the capital goods segment has fundamentally done much better than the reported numbers suggest. This is congruent with the quarterly reports of mid-size and large engineering and construction companies, (some of which have reportedly been awarded contracts for government-led capex spending). Their Q4 FY16 results have reported not just positive growth (in the range of 0-10%), but have also been significantly better than Q4 FY15 results. Hopefully, then, there are indeed signs of revival of this crucial segment of industrial activity.

Saugata Bhattacharya is chief economist at Axis Bank.

Sanket Tandon contributed to this article.

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