IIP Numbers for October 2016 Disappoints the Street

The Index of Industrial Production for the month of October 2016 came in at (-1.9%) compared to the October 2015 corresponding index number. Of the 3 key components of IIP viz. Mining, Manufacturing and Electricity, only electricity managed a marginally positive growth. While electricity showed a positive growth of 1.1% for October 2016 on a YOY basis, mining activity saw a negative (-1.1%) growth. However, like in the previous months, the real pressure on IIP came from the manufacturing sector which saw negative growth to the tune of (-2.4%) for the month.

As the chart above depicts, the core sector growth has remained strength but the IIP has failed to keep pace. Core sector growth accounts for nearly 38% of the overall IIP. Core sector covers the output of 8 key sectors including cement, steel, oil extraction, refining, electricity, natural gas, fertilizers and Coal. Within the above list, oil extraction and natural gas have continued to lag while cement and steel have just started picking up. The above chart clearly indicates that the real pressure on IIP is coming from the manufacturing sector. It needs to be remembered that manufacturing accounts for over 75% of the IIP and hence the trend line between manufacturing and IIP is likely to enjoy a very high positive correlation.

Understanding the break-up of the IIP number…

A total of 12 out of the 22 industry groups in the manufacturing segment of IIP have showed a negative growth. This is almost at par with the performance in the previous month. However, on a YOY basis, electricity growth has slowed down while mining and manufacturing have slipped deeper into the red. Some of the key sectors that have shown negative growth are electrical machinery, office equipment, computing machinery and wood products. On the positive side, coke, refined petroleum, motor vehicles, trailers and basic metals have showed a sharp positive growth for the month of October. The bigger worry could be in the use-based classification of the IIP. As per this classifications, capital goods has shown a negative (-29.5%) growth. This segment has been consistently showing a high negative growth below -20%. This segment is a good barometer of the pick-up in capital goods demand which is an indicator of the likely revival of the capital cycle. For now, there are no visible indications of any revival in the capital market cycle, which could mean that a quicker rise in IIP and GDP could be still some time away.

It would also be instructive to look at the key products that have contributed negatively and positive to the IIP. On the negative side, cables, rubber products, leather garments, gems & jewellery and aluminium extrusions have shown sharply negative growth. Most of these were largely demand related. On the positive side, Hot Rolled (HR) coils and high speed diesel (HSD) have pushed up the IIP. But the real good news is that there has been a spurt in production of commercial vehicles and passenger cars. Commercial vehicles demand could be an outcome of a good monsoon and a robust Kharif crop. Passenger cars, on the other hand, appear to be a direct outcome of the higher cash infused through OROP and 7CPC which has sharply expanded demand for entry and mid-level cars.

How demonetization will impact the IIP number?

That could be the million dollar question. This negative IIP growth of -2.4% refers to the month of October 2016. The demonetization was implemented effective November 09th. Although the demonetization process will get over by December 30th the liquidity imbalance will continue for at least another quarter. As on date, according to the RBI’s own statement, nearly Rs.12,00,000 crore worth of old notes have been impounded. Against that only Rs.4,00,000 crore worth of fresh notes have been issued. This gap will take another 5-6 months to fill up at the current printing capacity. That brings us to the bigger question of the impact on production.

These are early days but the pressure on business is already visible. Consumer sensitive sectors like automobiles, FMCG, retail, gems & jewellery and NBFCs have seen a sharp fall in footfalls to the tune of 30-40% in the last month. This is obviously going to translate into weaker demand and therefore weaker IIP numbers. This may actually manifest itself when the IIP numbers for November and December are announced.

Will it open the door for the RBI to cut rates?

One of the key factors influencing the RBI rate decision, other than the CPI inflation, is the IIP growth. The normal logic is that lower rates will make cheaper credit available to industry and therefore will help push up production. While the RBI may look to cut rates by 25 bps in February, its impact on IIP may be hard to predict at this point of time. Firstly, the liquidity crunch will hinder the smooth flow of funds and credit in the economy and hence may not bring tangible benefits in the form of higher growth. Secondly, most industries are operating around the 65-75% capacity utilization. That means, the real problem is insufficiency of demand. As India awaits the IIP numbers for November and December, addressing this challenge could be the big story!