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Tuesday, February 25, 2020

Explained: Why industrial production has contracted, what it means for the economy

The fall in IIP comes just a day after the Finance Minister quoted IIP data to argue the emergence of 'green shoots' in the Indian economy.

Written by Udit Misra | New Delhi | Updated: February 13, 2020 12:32:41 pm
Explained: Moody's cuts India outlook. What does it mean? The IIP is an index used to track the performance of the industrial sector in the Indian economy.

Just a day after Finance Minister Nirmala Sitharaman quoted the Index of Industrial Production (IIP) data for November 2019 as one of the evidence of the emerging “green shoots” in the economy, the Ministry of Statistics and Programme Implementation released the December data, which, in turn, shows that the IIP contracted by 0.3 per cent.

In November, the IIP had expanded by 1.8% after witnessing three consecutive months — August, September, and October — of contraction. A key reason for positive growth in November was the favourable base effect.

The latest contraction would predictably undermine the FM’s assertion about the economy turning around. On the whole, between April and December 2019, the IIP has now shown a cumulative growth of a meagre 0.5%.

According to the Quick Estimates of IIP released on Wednesday, in terms of industries, 16 out of the 23 industry groups in the manufacturing sector have shown negative growth during the month of December 2019 as compared with the corresponding month of the previous year.

In other words, the contraction continues to be widespread.

Explained: What is IIP?

The IIP is an index used to track the performance of the industrial sector in the Indian economy. It does this by mapping the volume of production. But since it is an “index”, it targets a basket of industrial products — ranging from the manufacturing sector to mining to energy — and allocates different weights to them. Then, depending on the production of this basket, it throws up an index value. The index value is then compared with the value of the index in the same month a year ago to arrive at a percentage growth or decline figure.

How is IIP data read?

There are two ways to understand the IIP data. One can either drill down the IIP data and look at the sectoral performance — where the whole industrial sector is divided into three sub-sectors, namely manufacturing, mining and electricity — or look at the use-based classification.

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What is the sectoral classification?

In the sectoral classification, manufacturing has the highest weight of 77.6%, mining has 14.4% share and electricity has 8% weight. In December, while production in mining grew by 5.4%, in manufacturing, which is the biggest chunk, production contracted by 1.2%; electricity contracted too, albeit marginally.

What is use-based classification?

Within the use-based classification, data is provided for six categories. These are :-

Primary Goods (consisting of mining, electricity, fuels and fertilisers) — this has a weight of 34%
Capital Goods (e.g. Machinery items) — this has a weight of 8%
Intermediate Goods (e.g. yarns, chemicals, semi-finished steel items, etc) — this has a weight of 17%
Infrastructure Goods (e.g. paints, cement, cables, bricks and tiles, rail materials, etc) — this has a weight of 12%
Consumer Durables (e.g. garments, telephones, passenger vehicles, etc) — this has a weight of 13%
Consumer Non-durables (e.g. food items, medicines, toiletries, etc) — this has a weight of 15%.

In December, while production of primary goods and intermediate goods has picked up, that of capital goods has contracted heavily. This shows there is little demand for new machinery, which in turn shows there is little enthusiasm in the economy to make new investments. The other three categories also witnessed contraction.

What about green shoots of the economy?

Observers who have tracked IIP for long argue that the key variable from the point of view of sustained growth or decline is the category of “intermediate goods”. That’s because it tallies with the order books. If intermediate goods are growing at a sustained pace month after month, then the domestic economy cannot continue to flounder for long. Similarly, if this category shows contraction, sustained growth appears far away.

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In December, this category has grown by 12.5%; in November it grew by over 17%, in October it grew by over 22% and in September by 7%. As such, there is hope that perhaps the economy has seen its worst.

However, the weakness across most other categories continues to be a matter of worry.

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