IIP contracts after 21-months gap: What does disappointing factory output means for economy

The IIP growth numbers for March 2019 and FY19 are more than disappointing. This information comes at a time when there are not too many encouraging signals at the ground level – auto sales being down in April, corporate results just about average, debt issuances being low, lower PMI etc. The dual disappointment at the monthly and annual level needs an explanation. First, the annual growth rate of 3.6 percent is even lower than 4.4 percent last year which is a great distance from the 8 percent + growth rates that were witnessed in the past. The puzzle here really is that 2018-19 was not an eventful year in terms of any disruptive policy or reform like demonetisation or GST. Yet the growth number has been much lower. It was widely expected that in the absence of any negative event, growth would touch the 5 percent mark. But this was not to be. Manufacturing in particular which has the highest weight in the index grew by 3.5 percent. [caption id=“attachment_4135661” align=“alignleft” width=“380”] Representational image. Reuters[/caption] This number will also feed back into the GVA growth number for manufacturing as around 25 percent of the output is in the unorganised sector which is represented by GDP growth. Therefore, there could be a slight downward bias in the GDP growth number to be presented by the CSO this month-end. Second, the monthly growth number at -0.1 percent is a shocker as while it is virtually flat, the negative number was last witnessed in June 2017. Therefore there is a psychological setback here. This number was unexpected as the core sector data for March was buoyant at 4.7 percent and would normally be associated with a higher IIP growth number. This was not so on two counts. The first is that capital goods production was negative at 8.7 percent. Here both electrical and non-electrical machinery grew at negative rates indicating that investment activity is dormant. Also, the auto component which gets into capital goods registered negative growth this month at 7.5 percent. The second relates to consumer goods which have not performed well this month. Durable goods production fell by 5.1 percent while non-durable goods increased by just 0.3 percent. In the case of durable goods, the household related auto component declined by 18.5 percent. This was known as the auto industry has been reporting low to negative growth in the last couple of months. Higher insurance cost, fuel and price of vehicles have come in the way of demand in general. At the non-durable level growth is anaemic and can be traced more to the FMCG companies that have reported low growth in sales in rural areas for Q4. Normally one may expect FMCG growth to be stable as these involve daily goods for which there are normally no substitutes. Quite clearly the low price realisation on farm products during the Kharif season did impact demand conditions in rural areas. While growth in capital goods, durable and consumer non-durable goods is positive for FY19 at 2.8 percent and 5.3 percent, 3.8 percent respectively there are no positive signals that things will change very soon. With the elections on and a new government likely to present a Budget in July, there will be no specific thrust on government spending. This is important because government spending has been the only constant positive factor all through the year as seen in the growth in steel and cement in the infra industry space. Therefore an infra push cannot be expected in the first quarter of the year. The states’ position is still delicate with most of them trying to manage to hold their deficits within the FRBM space and thus have little room for additional expenditure on capital. On the consumption side, the fact that growth has slowed down for consumer goods, especially auto, in the last few months is indicative of sluggishness which cannot be reversed immediately. Therefore it would be a gradual process before consumption picks up. It must be noted that consumption and investment are the two main drivers as they forge backward links with primary goods, intermediate and infra goods. If these do not fire, the process will be that much slower. What can be done now? In the short term, there is little that can be done. On the supply side, there will be a call to lower rates which will help in lowering costs but may not lead to higher growth in the absence of demand. Improving infra, providing credit, boosting exports, etc. will work only in the long term in case there is sustained effort put in. Demand has to be rejuvenated by creating an ecosystem that creates jobs at all level so that purchasing power is created that can propel the economy. Cash transfers which have been invoked by the government in the FY20 Budget and promised by the Congress too is a short term measure and will work to an extent but go with other problems like fiscal balancing. In this scenario growth in the first few months of FY20 will be subdued. In fact growth in the first 7 months of FY19 was high which will exert the base-effect downward pressure this year. The course of the monsoon and crop outcomes will drive rural demand. But this will be known only post-September. Till then it will be a gradual climb. (The writer is chief economist, CARE Ratings)