The initial frisson, on seeing a minus 3.2% y-o-y industrial activity shrinkage in November 2015, is sharp, particularly juxtaposed with the 9.9% growth in October. Manufacturing shrunk 4.4%, mining and electricity grew 2.3% and 0.7%, respectively. That the print would not be robust was known; our own forecast was 0.7%. The print on the core sector data released earlier (minus 1.3%) had pointed to an imminent weakness in the basic goods segment of the IIP—and this segment has a weight of almost 46% in the IIP.
Sure, to an extent, the weak data captures the effects of the holidays in October and November 2015, compared to 2014. Dussehra and Diwali days were entirely confined to October 2014, but spread over October and November in 2015. Broadly, there were 2 extra working days in October 2015 (versus October 2014) and 2 days less in November 2015. In a month of about 26 working days, this is roughly 8%. If we adjust the October 2015 IP index down by 8% and November 2015 index up by 8%, we get a synthetic 4.5% and 1.1% y-o-y growth for October and November 2015.
Yet, we can’t shy away from acknowledging that the festival season calisthenics will only cover up so much, and that industrial growth remains weak. December data is also likely to be modest, factoring in the effects of the floods in Chennai.
The proximate cause was a much-larger-than-expected slowdown in capital goods (minus 24%), which, in turn, is derived almost entirely from a massive 87% drop in rubber insulated cables, something beyond the pale of rational explanation. The press release reported a contribution of minus 2.27% to IIP (although this does not seem to add up, given the low weight in the IIP).
The IIP shrinkage would have been even worse had not gems and jewellery lent a helping hand with a 254% growth. The contribution of gems and jewellery to IIP is 1.46%, and it can be presumed IIP growth might have been about 1 percentage point lower without this extraordinary surge. Although, in principle, this is more explicable—presumed to meet Diwali demand—our initial channel checks suggested that festive season demand for gold and jewellery this year was more muted than before.
The puzzle remains why industrial activity, enveloped within some other high frequency economic indicators, continues to be so weak. CMIE data suggests that new project announcements have also slowed in the October-December 2015 quarter. Undoubtedly, weak exports are a partial explanation, merchandise exports, now estimated to account for 10-15% of export activity, netting out presumed import components. Exports in November had shrunk 24% y-o-y, more than or at the rates in previous months, and even factoring in the effects of the lower commodity prices (commodity prices had started coming off since September 2014), export volumes too are likely to have shrunk, contributing to lower IIP. Import substitution is also a factor; iron and steel imports are up 5% in volume terms in FY16 till October. Yet, the shrinkage is too large for explanation with even this narrative. Of particular concern is the large drop in capital goods index.
Although many initiatives of the government are yet to be implemented, the effects of some of the major steps like start-ups of some of the auction allocated coal blocks and some other mines, road contracts awarded through EPC and hybrid annuity schemes, power transmission contracts, urban infrastructure projects, etc, should have started showing up. One view is that the normal EPC procurement cycle is about 15-20 months, and given that awards of many of these contracts started towards the end of 2014, the spends arising from the contract implementation will start becoming visible over the next few months. Excess capacities (RBI survey indicates factories are operating at only about 70% of capacity) are not a cause for non-capex work slowdown, since production lines will be ramped up with increasing order flows.
The bigger puzzle is the increase in expenditures in general (and of capital spends, in particular) of the Centre and potentially of the states as well. Total plan and non-plan capital expenditures of the Centre during FY16 April-November quarter are up (incrementally, over the same months in FY15) by about R37,000 crore. The road transport ministry itself has spent R12,000 crore more cumulatively till November in FY16. Presumably, states have also upped their capex spends. Unlike project awards, these are actual payouts. Why are these spends not showing up in some economic indicators?
The news is not unremittingly bad. To get over the quirks of the individual festive months, it is better to consider a 2 or 3 month rolling average. Average growth during September–November 2015 was 3.5%, compared to 1.7% for the 3 months in FY15 (and 0.1% in FY14). The situation is improving. But the worry is that momentum remains muted.
Two remedies should be emphasised, each the subject of more detailed enquiry. One, the Centre needs to increase its capital spending. Given the constraints on revenue expenditures, the only way to increase capex spends is by monetising its considerable land and financial assets. Second, interest rates need to come down further. This is not just overall transmission into bank lending rates, but of government securities as well, given that higher yields will increase the interest burden, further compressing space for investment.
Tanay Dalal and Abhaysingh Chavan contributed to this article
The author is senior vice-president and chief economist, Axis Bank. Views are personal