IIP Growth Rate & Components

he Index of Industrial Production (IIP) for the month of January 2017 came in sharply higher at 2.7% compared to (-0.6%) for the month of December 2016. The IIP for January was important as it was the first full month of reported IIP after the demonetization drive was stopped on December 31st. Hence it was a good test case to evaluate if the remonetization drive since January had started to yield results. To that extent, the IIP number at 2.7% has surely kindled hopes that the IIP is on the way up and that is also ratified by the recent GDP advance estimates for the full year as well as the PMI-Manufacturing, which has gone back above the 50 mark post-demonetization. But first a break-up of the key components of the IIP number…

It was Manufacturing that gave the big push to IIP in Jan 2017…

The IIP has 3 key components viz. Mining, Manufacturing and Electricity. For the month of January 2017, mining grew at 5.3% (sharply up from 1.5% in Jan 2016) and electricity grew at 3.9% (sharply down from 6.6% in Jan 2016). But, it was manufacturing that turned around from negative growth of -2.9% to a positive growth of +2.3%. This had a much larger impact on the overall IIP number since manufacturing has the highest weightage in the index and therefore tends to have an outsized impact on the overall IIP number. Of course, the key will be sustainability of the IIP number, especially the manufacturing performance. The numbers of February and March, if they sustain at positive levels, will give the first indications of a pick-up in IIP post remonetization.

Sectoral Trends in the IIP growth for Jan 2017…

The sectoral trends also reflected strong remonetization bias. Among the major positive sectoral contributors were cables, HR Coils, minerals and passenger cars. While HR coils have continued to benefit from a salutary regulatory environment, passenger coils have been the real beneficiaries from a revival in retail demand post demonetization. The negative contributors to IIP are the standard suspects. Sugar output has been weak due to slack in sugarcane output as well as leverage related issues. Gems & jewellery has also seen negative growth for January, largely due to the collateral impact of the demonetization drive. Cement has also taken a hit on production as many cement manufacturers are being forced to curtail production to ensure that prices stay buoyant in the cement market, especially considering that construction demand has still not shown distinct signs of picking up.

Use-based classification of IIP…

Another interesting way of looking at the IIP number is to look at use-based classification. In terms of use-based classification, the capital goods segment saw a sharp 10.7% growth in the month of January 2017. While that could be partially attributed to the base effect, it has also been driven by the remonetization boost that has improved liquidity in the corporate sector. Intermediate goods have shown negative growth of -2.3% in January but that could be largely attributed to the pressures that the SME sector has faced in the aftermath of demonetization. Of course, this could take a little more time to correct itself since the SME space may not have the same financial resilience as the larger corporates.

In terms of user-based classification, consumer goods have continued to grow at a negative rate of (-1%) in January 2017. Within the overall gamut of consumer goods, consumer durables have grown at 2.9% while the consumer non-durables have continued to show negative growth at -3.2%. The difference is quite subtle in this case. In case of consumer durables, the demand pattern has been essentially an urban phenomenon where the digital money usage is already quite rampant. On the other hand, the consumer non-durables space is essentially a rural and semi-urban market in terms of volume mix. That segment was already seeing a slowdown due to weak rural incomes and the demonetization drive has only accentuated that problem.

What is the outlook for IIP and RBI rate trajectory from here on?

Let us talk about the outlook for IIP first. The good sign seems to be that capital goods segment is showing signs of revival and that could speed up the revival of the capital cycle. That is something that India has been waiting for a very long time. The next few months will make the picture clearer. We expect that if there are no negative surprises globally, then IIP could sustain at around these levels for the next couple of months. That could be the good news. Also, by the middle of April, the remonetization should be largely completed from an operational perspective. That could give a big boost to growth. The big challenge for the government will be spurring rural demand as that is what will lead to a full-fledged revival in IIP growth.

What does this IIP number mean for the RBI rate action? That may largely depend on the inflation trajectory as depicted by the CPI. For starters, the RBI has already shifted its monetary stance in the last policy from accommodative to neutral. With most banks dropping their MCLR by 90 to 100 basis points, there is little scope for boosting IIP via the rate cut route. Hence, the IIP figure may not really impact the RBI thinking on the repo rates. That is something Indian financial markets will have to be eminently prepared for.