The 2.6% year-on-year increase in July industrial production, when most expected the contraction trend of past two months to persist, came as a surprise. That this unexpected rebound is driven solely by a 15.6% jump in capital goods’ growth has led many to conclude the data are one-off; a recovery will be weak and unlikely self-sustaining. However, relating capital goods and exports, which grew at 12-13% in two consecutive months to August, historical patterns portend a self-enforcing, virtuous cycle ahead, largely built upon strengthening external demand, supported by domestic rural consumption.
Investment and exports move in close, positive association at least from the 2000s. At monthly frequency, capital goods’ growth is in fact, a fairly robust predictor of future exports with a two-three month lead as the accompanying chart shows, using IIP and trade statistics from mid-2006. The strength of the exports-investment relationship also holds when examined from quarterly national accounts statistics (see chart). Gross fixed capital formation growth (GFCF), which reflects the rate at which new assets are created relative to previous year’s comparative base, co-moves closely with exports growth in more than a decade-long trend.
This isn’t as surprising for nearly two-thirds of Indian manufacturing is directly or indirectly linked to exports; moreover, much of the capacity addition in manufacturing during the five-year boom to 2007-08 was geared towards foreign demand. Further, some production capacity, especially in small and medium enterprises segment (about 40% of manufacturing, 30% of non-farm employment), is oriented to both domestic and foreign markets; production in such units becomes viable only at a scale typically provided by export orders. Such is the intensity of investment-export links.
Moreover, the IIP doesn’t capture the entire manufacturing sector. Past data revisions are instructive as to the extent of underestimation of manufacturing output as well as its synchronisation with the global business cycle. Consider the hefty revision to 2010-11 GDP growth: This was reworked to 9.3% (8.4% earlier) in January 2013; primarily because manufacturing output was revised upwards by 2.1 percentage points as ASI data (this has much broader coverage than the high-frequency IIP) became available. Then again, GFCF growth