The November factory output number is a crucial reminder to Union Finance Minister Arun Jaitley that not all is well yet in the real economy and he needs to work on his priorities well to save the Narendra Modi government’s high-growth agenda. Clearly, growth concerns should be dealt with much bigger urgency than inflation, which has so far obliged to the glide path of the Reserve Bank of India.
The government should work to ensure investments (both on public spending and private sector commitments) sustain in the economy and there is a simultaneous demand-driven growth by putting more money into the pockets of common man. In the absence of these triggers, it will be difficult to even match last year’s growth numbers (7.3 percent) even with the revised down growth targets (7-7.5 percent as against 8-8.1 percent earlier). A painful slowdown in exports complicates the problem.
It's seasonal and statistical
Having said this, the sharp contraction in November Index of Industrial Production (IIP), at a four-year low of negative 3.2 percent, compared with 9.9 percent jump in the previous month, is also on account of seasonal factors and base effect. The number does not warrant a panic since monthly IIP numbers are typically of high-volatile nature.
Even when the near double-digit spike in IIP thrilled the Modi camp in October, Firstposthad warned that it is too risky to celebrate the number, since the spike was mainly on account of festival season consumer spending, typical every year that might not sustain. This is precisely what happened in November.
Let’s look at the seasonal and statistical factors first. On a higher base last year, the corresponding number this year will show lower. The IIP index spiked in November last year weighing on this year’s number. Secondly, the festival season linked consumer demand has evidently failed to sustain momentum. While the consumer durables segment grew about 42 percent in October, the growth in this segment has shrunk to 12 percent this year.
"The steep decline in industrial output in November should be seen in tandem with the sharp rise in the previous month since Diwali related distortions are at play. Doing this still suggests that the momentum has weakened a notch; partly due to the impact from floods affecting an industrial hub in Southern India. All this indicates that the 9.3% manufacturing GDP uptick seen in the previous quarter is not likely to sustain," said HSBC Global research in a note.
But there is more
Even if one factors in the seasonal factors and the Chennai flood-impact, there is a notable drop in output visible across key segments, also indicated by other high-frequency indicators. This is what should worry Jaitley.
“November IIP was clearly disappointing even after factoring for festival season-led lower working days and lower production,” said Suvodeep Rakshit, Economist, Kotak Institutional Equities. “Capital goods production contracted sharply which by nature is lumpy and volatile. Most of the manufactured products sub-components registering sequential contraction beyond the normal seasonal effects will re-cast doubts on the durability of the recent robustness in the IIP,” Rakshit said.
The core production and investment indicators too have fallen sharply in November. The manufacturing sector posted a contraction of 4.4 per cent in November as against a growth of 10.6 per cent in October. This decline has reflected in other segments such as electricity (fell from 9 per cent to 0.7 per cent) and mining (fell from 5.2 per cent to 2.3 per cent). That apart, the investment activity in the economy too has slowed down as indicated by the capital goods numbers. This segment contracted sharply by 24.4 per cent compared with a growth of 16.3 per cent in the previous month.
This was expected since the core sector growth and the PMI numbers too indicated serious problems on industrial production side. The latest core sector data showed the growth in eight core sector industries, which constitute close to 40 per cent of the total factory output, contracted by 1.3 per cent, indicating slowing production across segments. This had to be reflected in the November IIP.
Similarly, the sharp fall in Nikkei India Purchasing Managers Index (PMI) in December to 49.1 from 50.3 in November — the first contraction in two years and at the sharpest rate in almost seven years or since the time of the 2008 global financial meltdown, too showed nothing but a poor production in real economy. Continuing low-bank credit growth indicates supports this argument.
A few things are now becoming clearer:
For one, apart from the fact that seasonal factors and impact of fading base effect have contributed to the November IIP contraction, it is becoming increasingly clearer that the investment cycle in the economy is yet to turn the corner. The only silver line in the recent months was the government continuing with its spending. Jaitley has to make sure this is sustained even at the cost of the government overshooting the fiscal deficit targets by a few basis points. It is unwise to expect the private sector to chip in at this stage.
Two, in an economic scenario, where large investments are absent, the trigger for economic growth should come from domestic demand. The 7th pay commission and OROP would put more money in the pockets of people. If Jaitley’s upcoming budget favours individual taxpayers, this could add to the positive sentiment.
Three, it is now even more critical to push hard the reform agenda. The Goods and Services Tax (GST) can be a game changer since it can act on both fronts — boosting the investor sentiments on the Modi-government’s reforms intent and improving the tax collection by way of broadening the tax base. It is up to the BJP’s backroom strategists to work out ways to bring back the Congress to the discussion table and reach consensus. Besides GST, the government should pursue other reforms which can be pushed as executive decisions.
On the other hand, the spike in retail Inflation, even at 5.61 per cent in December, is not too big a concern since it is well within the January, 2016 target of the central bank though, if it persists, would mean that 2016 wouldn’t be a year of sharp rates cuts as the pace of disinflation is expected to be slower.
For now, the bigger concern for the NDA government is growth, more than inflation. So far, the economy hasn’t seen ‘acche din’ with respect to fresh investments and significant pick-up in ground-level economic activity. Cracked corporate balance sheets and lackluster industrial activity testify this fact.
Jaitley, who have acted too late on critical issues such as bank recapitalisation, will have to now work even harder to change the course of economy. There aren’t any short-cuts.