April IIP contraction should draw Modi govt out of the growth delusion

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A man welds together steel wheels, part of equipment used for packing medicine, inside a manufacturing unit in the western Indian city of Ahmedabad December 12, 2011. India's industrial output fell in October for the first time in more than two years as capital goods investment slumped, ramping up pressure on the central bank to ease monetary or liquidity conditions, possibly as soon as Friday. REUTERS/Amit Dave (INDIA - Tags: BUSINESS EMPLOYMENT TPX IMAGES OF THE DAY INDUSTRIAL)

The factory output growth in April, at negative 0.8 per cent, compels the Narendra Modi government to take a break from the celebrations post the 7.9 percent GDP number and acknowledge the tricky pits on the road to a painful economic recovery. The main takeaway from the Index of Industrial Production (IIP) numbers in April is the very clear absence in the private investments pick-up. This has dragged down the overall investment activity as reflected in the capital goods segment.

This segment declined close to 25 percent in April, marking the fourth consecutive month of contraction. Economists look at capital goods to gauge the investment activity on the ground. The primary reason why this segment has fallen so much in April is the absence of private sector investments and inadequate impetus from the public spending.

“The use based figures show that lack of momentum in private investments is possibly taking a big toll on the capital goods sector that has now contracted for the sixth consecutive month,” said Rishi Shah, economist at Deloitte.

“A near term recovery in the industrial sector looks difficult and growth will remain crucially dependent on how demand shapes up in the period after the monsoons,” said Shah. Stagnant investments impact fresh capacity generation in the economy, economists said, besides affecting even the ongoing projects. This acts as a major drag on growth recovery.

Next, take a look at the manufacturing sector growth. The segment has contracted 3.1 percent as compared with a growth of 2 percent in the previous month.

Separately, the recently released PMI numbers too had pointed out to a slowdown in manufacturing activity. The Nikkei/Markit data showed that manufacturing output in the country grew at its slowest pace in five months in May, suggesting that the sector is “barely improving”.

The composite indicator of the manufacturing sector performance, stood at 50.7 in May as against 50.5 in April – one of its lowest readings since the end of 2013. A reading above 50 represents expansion while one below this level means contraction.

Nine out of 22 industry groups have shown a contraction in April IIP. The only support has come from the electricity generation, which has grown by 14.6 per cent as compared with 5.6 per cent in March. But, when the manufacturing is not doing well and industry is struggling what is the trigger for spike in electricity generation is a question.

On the positive side, the continuing momentum in consumer durables segment (mainly manufactured items such as TV, cars, refrigerators etc) shows there is still demand from individual consumers. As Firstpost has noted earlier, consumption appears to be the key growth driver in the backdrop of lackluster investments. But, a good monsoon is critical for this consumption momentum to continue.

One reason why economists warned on early celebrations when the government went to the town boasting on the 7.9 percent GDP growth in the Jan-March quarter, was that the figure is bolstered mainly on account of private consumption and the ‘discrepancies’ component that is overstating the growth. There again, the bad news in the data was that private investments didn’t show a pick-up the way it should have, while public investments have remained almost flat.

That prompted the economists to caution on the GDP numbers. The biggest proof they pointed out was the gross fixed capital formation (GFCF) figure, which indicates investment activity on the ground. For the full year, GFCF has grown by 3.3% compared with 7.9% in the previous year. As a percentage of GDP, the GFCF has dropped to 29.3% from 30.8% in the preceding fiscal. That showed that the investment scenario clearly remained weak.

The bottomline is this: Growth recovery remains weak. That makes no alternative for finance Minister Arun Jaitley to significantly increase the public spending in the approaching months if he is serious about growth revival. The government has been improving public spending but it has failed to keep up the momentum in the desired manner.

This is particularly important in a scenario where private investment cycle simply refuses to pick up, despite all the talk on growth. What is more important is that the PM Modi, who is campaigning hard to put the economy back on the growth track, shouldn’t let false growth notions dominate the government’s thought process, which will be counter productive. Acknowledging the problem is the first step taken to solve it.