Falling Index of Industrial Production

Context

Recently the Index of Industrial Production (IIP) reached to a low of –4.3% (September 2019). It was exacerbated by a manufacturing slowdown of –1.4%. This is the deepest negative growth in the 2011-12 series; more than seen in the previous 2004-05 IIP series.

About

  • There is sharp contraction in the IIP (factory output), to an eight-year low of a negative 4.3% year-on-year (y-o-y).
  • In terms of industries, 17 out of the 23 groups in the manufacturing sector
  • Core sector data measuring the eight infrastructure sectors contracted2%, worst in 14 years. Core sector constitutes 40% of industrial production.
  • All components of industrial output—mining, manufacturing and electricity—fell during the month, pointing towards a deepening economic downturn.
  • The top negative contributors to negative IIP were mining, bars and rods of alloys and stainless steel, auto parts, commercial vehicles and two-wheelers.
  • Demand is clearly weaker than perceived and consumer confidence is severely dented. Business confidence has slipped to lowest level in past two years.
  • Signalling a continuing slump in consumption demand, both consumer durables and consumer non-durables also contracted.
  • There is contraction also in capital goods segment (driven largely by commercial vehicles (CVs)) indicating that investment demand in the economy is shrinking, and that companies are not adding capacity.
  • The pace of growth of intermediate goods such as cotton yarn, plywood and steel pipes halved to 7%.
  • The IHS Markit’s purchasing managers’ index (PMI), based on a survey of 400 producers, also fell. Job creation fell to a six-month low, while companies were reluctant to hold excess stock and lowered input buying.
  • Auto manufacturers have been producing less in order to reduce inventories that piled up earlier.
  • The infrastructure and construction sectors have been sluggish for a long time now.
  • Key sectors such as defence have attracted little FDI.
  • Highest positive contributors to IIP were basic metals (driven largely by mild steel slabs), fragrance and oil essentials, hot-rolled coils, electric heaters and medicinal formulations.
  • MS Slabs are used in the hydraulic press and machinery industry. This explains the growth in the intermediate goods user industry segment, which some analysts say will contribute to imminent recovery of IIP.

Reasons for fall in IIP

  • Tight credit conditions are making it hard for all, except for top-rated borrowers, to access loans at affordable rates. This is hurting demand and business.
  • After the NBFC crisis, companies and individuals have been finding it harder to get affordable loans; disbursements by NBFCs and HFCs fell 32% y-o-y in Q2FY20. Overall loan growth seems to have slumped to 6%.
  • One can’t blame lenders for being risk-averse, since it is a fact that credit profiles of most companies are far from robust and, in many cases, are deteriorating.
  • The sharp IIP de-growth was, in large part, due to a persistent negative growth in capital goods.
  • IMF and other agencies have downgraded India’s growth forecast, which is emanating mostly from slowdown in manufacturing segment. Sectors in manufacturing segment where growth contracted were mining, electricity generation, petroleum and consumer durables.
    • Growth in mining contracted due to the excess, prolonged rains in the mining belts.
    • Negative growth in petroleum refining might have been due to some maintenance related refinery closures.
    • Weaknesses in consumer non-durables (FMCG) are representative of squeezed purchasing power, and hence, demand weakness.
    • Contraction in electricity generation has been led by multiple factors, including weaker demand from industry, curtailed production schedules, low domestic demand and farm off-take related to higher than normal rainfall.
  • Global economy is also suffering from low growth conditions, and its affect gets amplified for emerging markets like India.
  • Diesel consumption has sharply decelerated and a continuing vehicle sales slowdown will inevitably impact transport activity in an adverse way.
  • The late withdrawal of the monsoon is likely to have dampened construction activity in various states, contributing to the contraction in the output of infrastructure/construction goods.
  • Seven out of the eight core industries showed a contraction. Coal was the worst performer on account of an extended monsoon, a surge in renewable energy supply and labour issues at state-run Coal India Ltd. Coal accounts for a substantial share of the freight moved by the Indian Railways and the country’s power generation capacity. Of India’s installed capacity of 360 GW, 54% is coal-fuelled.
  • Slowdown in growth of intermediate goods stands out as the biggest contributor to the sequential slippage in IIP growth.
  • Weakening demand had a domino effect on the manufacturing industry, knocking down production, employment and business sentiment.

Solutions to revive IIP

  • Without an investment revival, there is little hope of the economy clocking more than 6%.
  • Even as the government works on longer-term measures to revive the economy, it must find a way for businesses and individuals to be able to access loans and, at the same time, speed up payments so cash flows back into the economy.
  • The onus is on the government to spend more; schemes such as the Rs. 25,000 crore funds for the real estate sector to complete stalled housing projects will boost cement and steel sectors and will go some way in reviving demand.
  • However, over the longer term, government must ensure that regulation is unbiased; else, we will see wealth destruction of a colossal magnitude as we have seen in telecom.
  • The Reserve Bank of India has slashed its policy rates for the fifth time this year (as of November 2019) to support growth.
  • There is need to design an optimal mix of policies to reverse this deceleration. The scope for a strong monetary policy response is limited.
  • The administration has given a cut in the corporate tax rate. This too will prompt companies to invest more.

Conclusion

The Indian economy is battling a severe demand slowdown and a liquidity crunch, which together resulted in the GDP growth rate and growth in private consumption expenditure falling. The slowdown in the economy is likely to have an adverse bearing on policymakers’ goal of doubling the size of the economy to $5 trillion by 2024. Hence, it is important to arrest the falling industrial production at the earliest, in order to revive growth.

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