IIP contracts again: Modi govt is dealing with a problem, not just a statistical illusion


The factory output data released on Monday evening wouldn’t be comforting set of numbers to the Narendra Modi government.

There are two ways to look at the second consecutive month of contraction in the Index of Industrial Production (IIP) by negative 0.7 percent in August compared with negative 2.5 percent in the preceding month.

First, one can argue that the IIP numbers are largely irrelevant because of the outdated base (2004-05) and IIP numbers need to be taken seriously only after changing the base to 2011-12 as is the case for GDP calculation.

Second, to acknowledge that there is indeed a problem particularly with regard to the visible absence of private investments. This has been the core reason that has dragged the broader factory output to negative arena all along.

This sceneario is not different in the August IIP numbers too. The question arises: Is the consecutive contraction of factory output on account of the second reason, rather than the first or is there a deeper issue? Take a look at the numbers a bit more closer to understand this.

All the nine components that constitute the industrial production index have clearly continued to disappoint in August. The poor performance is more visible on three critical areas — manufacturing, capital goods and electricity. The manufacturing segment has shown a contraction of 0.3 percent and capital goods 22.2 percent, while electricity witnessed a growth of 0.1 percent.

Of these three, note the capital goods part, which is the actual indicator of investment activity on the ground. In July, this component had contracted close to 30 percent. This month, there is a slight improvement, but still in the negative. This is the crux of the problem.

“Production trends yet so far this fiscal year have disappointed, pointing to an extended lull phase for the private sector investments. Expectations are that positive demand impulses in the pipeline, including high public sector wages, normal monsoon and an accommodative monetary policy will be the key domestic catalysts for factory output, as external demand flatlines. Meanwhile, markets will look for a rebased industrial production series due late-2016 or early next year, to update the data series and bring it in line with the rebased GDP dataset,” said Radhika Rao, economist at Singapore based DBS Bank.

As Rao says, when the base year is corrected, the IIP numbers might show a marked improvement, the same way the GDP numbers jumped when the method of calculation was changed beginning 2013-14. But, will that solve the problem.

It is difficult to believe that it will. Reason, a host of other indicators too point to the problem of scarce private investments acting as a major drag in the economic recovery process.

This is something Firstpost had highlighted when the GDP numbers showed high growth. Much of the growth was generated by consumption and certain technical reasons (discrepancies component) not on account of a revival in private investments. When the growth is hanging solely on the consumption push and not fresh capital generation, economists tend to develop skepticism on the sustainable nature of the recovery process.

Now, take a look at the bank credit growth. The bank lending to overall industries have been almost nil in the recent years. Banks have been largely looking at the safer retail loan portfolio to growth their books. Here, one can argue that companies are crowding the money markets and banks are investing in their papers, hence bank lending data is irrelevant. But, that is a weak argument.

This is because only top rated companies have the luxury to tap the bond market. What about the small and medium sized firms for which bank counters are still a no-go area? Banks will reason with you that theer NPAs are high and unless these firms improve their balance sheet health, they won’t get fresh loans. Companies would say unless banks restart the lending process their financial health wouldn’t improve. This creates a chicken and egg situation. But, the point here is that bank lending data too correlate with lacklustre core sector growth.

Thirdly, one should also note what are the rating agencies talking about corporate health. A recent note released by Icra says in the first half of fiscal year 2017, it upgraded the ratings of 287 entities and downgraded 314, in relation to a total of around 7,000 entities whose ratings were outstanding at the beginning of the fiscal year. The Credit Ratio, or the ratio of upgrades to downgrades, remained at 0.9 time, similar to the ratio in same period last year.

What this basically suggests is that “a meaningful improvement in the credit quality of Indian entities is not apparent yet”.

“Overall, broad-based recovery in credit quality not on the horizon yet. This is contrary to the perception that credit quality has recovered in the first half of the current fiscal,” the agency said.

This means there is a problem beyond the base year calculation in the downward trend on IIP, a problem of lack of private investments and continuing poor corporate health.

Now, what should be done?

Clearly, there is no magic wand with finance minister Arun Jaitley to make the problems vanish in a moment. But, he could engage with the private sector more actively to put money on the table. Also, the public spending that acted as a major catalyst needs to continue with pace. Despite the hype over the Modi government’s investment focus, the fact remains that there has not been a substantial jump in private investment to support growth. The government needs to acknowledge the problem and see what can be done to crack it.

The continuing drag on the core sector growth, which constitutes 38 percent of the factory output, will put more pressure on the Monetary Policy Committee to cut rates even further. One shouldn’t be surprised if RBI governor Urjit Patel announces one more rate cut in December and make a comment that growth is a bigger concern now than inflation.