Should we be worried about the Purchasing Managers’ Index (PMI) number for manufacturing for December? The index has come at 49.1, which is an all-time low since March 2013, and has also turned negative for the first time since October 2013. A score of less than 50 indicates a decline in confidence, while any number above this is positive.
The PMI is a survey-based number where around 500 private sector companies are polled and asked specific questions on new output, employment, delivery, stocks of purchases and new orders. The respondent has a choice to say things are ‘better’, ‘worse’ or the ‘same’ for the month compared with the previous month, with different weights being assigned to these parameters. With scores of ‘1’, ‘0’ and ‘0.5’, respectively, intuitively it may be observed that if all say conditions are unchanged, the score would be 50, and if the majority pitches for a decline, then it goes below 50. As a corollary, if the number keeps moving upwards, it will indicate sustained improvement in confidence. As most of these parameters change quite gradually, the PMI, per se, cannot be seen to be moving sharply at any point of time and would be like a crawl-in-a-tunnel.
The issue with the PMI is that it is based on a survey of only private companies and excludes PSUs, which could be dominant in some sectors. Also, the SME segment gets included, which has a significant role in overall production. Further, it is based on a comparison with reference to the previous month and hence involves a more immediate outlook. That said, the PMI is an early indicator of the shape of things to come in the manufacturing sector and cannot be ignored. As it includes an impression on new orders, there is some element of being forward-looking, which is refreshing. In addition, views on stocks and deliveries give some idea of the state of business and cannot be ignored. But does it correlate well with production?
The answer is ‘no’, as the composition of the production index, the IIP, varies, as does the point of comparison. In case of the IIP, production is compared on a year-on-year basis, while the PMI looks at it month-on-month. Further, the PMI is based on an impression, while the IIP is based on physical numbers of production. Therefore, the two may not be expected to move together.
For instance, the PMI for December says that confidence level is low and has declined. The IIP growth number till October shows an increase of 5.1% as against 1% in the same period of last year. Therefore, the picture in terms of production still looks positive. Besides, for industrial production, it always makes sense to look at cumulative growth numbers, as production is a continuous process over a year and by looking at monthly numbers there are distortions in terms of base effects as well as spillover of reporting, which create spikes. Deliveries especially can spill over from the previous months and the same could be recorded differently. A smoothened number is the cumulative one, which is free from seasonal influences too, and going by this approach, manufacturing is not doing too badly and we can be confident of a growth of 4-5% this year—an improvement over the 2-3% that we witnessed in FY15.
The PMI number, though susceptible to change in perception over months, does give a fair picture of confidence levels, and hence is a barometer of the shape of things to come. However, for a meaningful interpretation, trends need to be observed rather than single numbers, which would be susceptible to distortions due to seasonal factors as well as specific incidents like, say, flooding in Chennai or additional holidays in a month.
Given that the PMI has been in the vicinity of 50 and not really moving upwards significantly, it is possible to conclude that conditions look fairly lacklustre. This is also supported by the fact that there is not much investment taking place in this sector and surplus capacities exist across industries to the extent of 30% or so. In addition, as December marks the end of the festival season—demand is typically satiated in the months of October-November when spending increases—the overall confidence level would tend to move downwards unless there is an upsurge in demand subsequently.
The major takeaway for us is that the manufacturing sector is still just about moving in a stable manner and the outlook is unchanged. It may be expected that this mood would continue to prevail till the end of the year, considering that a fundamental shift in production is not really expected. This would come as a disappointment, as it was expected that the industrial recovery would become pronounced in the second half of the year based on all the efforts that have been put on the policy front.
More importantly, there are growing concerns on government spending too, which was to be a prop this year on two counts. First, the income growth could be constrained by the pressure, with some concern being on the disinvestment programme that has yet not taken off. With the stock market gyrating downwards due to international developments, the timing too does not appear to be favourable.
Second, the disinflation in the economy has lowered the nominal GDP, which will upset the fiscal deficit ratio even if the absolute level is met. Growth of 11.5% was assumed in the budget, but with this number coming down to 9%, the fiscal deficit may have to be reduced by around R25,000 crore to meet the target of 3.9%, or else we have to settle for a revised figure of 4.1%. Adherence to the target would mean some cuts in capex that will impact demand and hence manufacturing output.
Therefore, the PMI—which cannot really be taken to be representative of the production scenario—is useful because it is forward-looking and indicates, to an extent, the future environment. Although a one-time slippage to less than 50 is not alarming, any conversion to a trend can send negative signals of future growth prospects in the manufacturing sector.
The author is chief economist, CARE Ratings. Views are personal