It tells us a lot about the state and level of expectations about the economy that even a 4.3% year-on-year increase in the index of industrial production (IIP) for August is hailed as a “nine-month high”, “signalling a turnaround”, “cause for cheer”, “Diwali boost”, and so on. The markets, too, have celebrated, with the Sensex rising 250 points and the Nifty-50 index of stocks closing at an all-time high of 10,167 on Friday.
While it is necessary to be optimistic — business is ultimately about sentiment and the confidence that things will get better — caution is warranted on at least two counts.
First, it’s not clear how much of the apparent rebound is due to the so-called restocking effect. Prior to the Goods and Services Tax (GST) kicking in on July, distributors and retailers resorted to “destocking” – selling from their inventories rather than purchasing new goods attracting the existing state value added taxes, on which claiming credit under the new regime wouldn’t be easy.
It led to manufacturers, then, cutting output in June. Uncertainty around the new tax regime meant that production even in July was at a low key. Only in August would it have resumed at full throttle, and mainly to “restock” warehouses ahead of the festival season. The fact that overall industrial output fell by 0.2% in June and went up marginally by 0.9% in the following month, before recovering to 4.3% in August, seemingly confirms this hypothesis.
But restocking alone, which is a one-time affair, cannot obviously sustain a recovery in the months ahead.
Secondly, the August data itself needs to be looked at more closely. The manufacturing sector, which has a 77.6% weight within the IIP, registered a mere 3.1% annual growth in August. And out of its 23 subsectors, as many as 13 posted negative growth. That includes textiles, wearing apparel, leather goods, rubber and plastic products, chemicals, paper, furniture, beverages and tobacco — most of which are highly employment-intensive industries.
Even if one were to go beyond the IIP, the picture right now looks mixed at best.
Thus, on the one hand, we have cement production — a proxy for construction activity — falling year-on-year every single month from December to August. But on the other, commercial vehicle sales have shown strong growth of 25.3% in September, 23.2% in August and 13.8% in July — after recording very low/negative numbers of 1.4%, minus 6.4% and minus 22.9% in the preceding three months, and just 4.2% for the whole of 2016-17. That would suggest things have started moving, literally, at least from the last quarter.
It raises the question: what really is moving?
Chart 1 plots monthwise manufacturing growth rates since February 2016. It points to a clear trend of decline, particularly visible after November when demonetisation happened. The nine months before demonetisation saw an average year-on-year growth of 5.8%, which fell to 1.7% for the nine months from December.
The second chart shows the corresponding growth rates for non-oil imports over the same period. What emerges is quite the opposite: the average year-on-year increase for the nine months from December to August works out to 21.3%, whereas it was minus 8.5% for the earlier pre-demonetisation period from February 2016 to October 2016.
What do these trends indicate? Well, manufacturing has clearly taken a hit from the twin blows of demonetisation and GST, one following the other. Earlier, the sector was chugging along, even if not roaring. The liquidity crunch resulting from demonetisation basically ended up disrupting domestic production supply chains. Small and medium-sized enterprises (SMEs) in manufacturing clusters, paying workers mostly in cash, were the worst affected.
Liquidity did return to the system around February-March. As the pace of remonetisation picked up — the notes in circulation by end-March, according to the Reserve Bank of India, had almost reached three-fourths of their pre-demonetisation levels — demand was somewhat restored. But by this time, many domestic manufacturing units, especially SMEs, had shut shop or significantly cut back on production. And with GST subsequently adding to their woes, it meant that the demand — even if not fully back to normal — was increasingly being supplied not by domestic production, but imports.
During April-August, manufacturing growth has averaged just 1.6%. Compared to this, the country’s overall imports for the same period have surged 27.5% year-on-year. Even after excluding crude petroleum and gold — both of which are, in any case, imported — the growth rate amounts to 23.2%. Imports rising by 20%-plus, in an economy combating a severe growth and investment slowdown, is quite unusual. If imported goods are what are largely being moved today, it might not be the best of news — whether for the current account deficit or for jobs in India.
Rebuilding broken domestic supply chains will involve either the SMEs adjusting to the new tax regime or the formal sector filling in the space ceded by informal manufacturers. Both these will take time. Until then, imports are inevitable. And without manufacturing getting back on the rails and the capital expenditure cycle resuming, there can be no recovery either.