After Effects Of Demonesation On IIP For Dec 2016

The Index of Industrial Production (IIP) for the month of December 2016 came in at (-0.4%), sharply lower than the positive number of 5.6% growth recorded in the month of November. The pressure on IIP was expected to manifest itself in the month of December due to the cumulative impact of 2 months of demonetization. The demonetization drive had created a huge liquidity mismatch in the system and that had created three negative ripples in the economy. On the one hand, treasuries of most companies had gone slow on spending to conserve cash till the time the mismatch situation got better. Secondly, customer-facing sectors like FMCG, automobiles and consumer durables were the sectors to be hit the most as consumer demand was postponed. Thirdly, sectors that entailed a higher degree of cash usage in their operations faced the brunt. This included sectors like gems & jewellery, cement, construction etc.

The interaction of IIP, Manufacturing growth and Core Sector…

As the monthly chart depicts, the IIP has tended to diverge from the core sector growth. The IIP has shown a much higher correlation with manufacturing growth; which is hardly surprising considering that Manufacturing accounts for a bulk of the constitution of IIP. The IIP growth over the last 18 months has almost tailed the growth /de-growth in the manufacturing sector. It is the manufacturing sector that bore the brunt of the demonetization. The other two components of IIP viz. mining and electricity have a very small weightage in overall IIP. Additionally, both the mining sector and the electricity sector are more a function of government policy and that has not really been impacted by demonetization.

How the 3 components of IIP stacked up…

Out of the 3 key components of IIP viz. Mining, Manufacturing and electricity, it was manufacturing that disappointed during the month of December. While Mining grew at 5.2% and electricity grew at 6.3%, it was manufacturing that showed a negative growth of (-2%). This is what led to the overall IIP showing negative growth of (-0.4%). However, mining has a weightage of 14.16% in the IIP while electricity has a weightage of 10.32%. Therefore, it is manufacturing with a weightage of 75.52% that exerts an inordinate amount of pressure on the overall IIP.

How manufacturing exerted pressure on the December IIP…

The pressure on manufacturing was evident from the fact that out of 22 sub-groups in manufacturing, 17 showed negative growth. Had it not been for 11% growth shown by basic metals and 9.8% growth shown by communication equipment, the actual manufacturing number could have been much lower. The pressure on office budgets was visible with the biggest de-growth of (-23.9%) coming from office, accounting and computing machinery. Transport equipment also took a hit. In terms of major negative contributors there was de-growth visible in commercial vehicles, gems & jewellery, motor cycles and cement. The reasons are not far to seek. Cement and gems & jewellery were hit by the restrictions on cash transactions. On the other hand, commercial vehicles and two-wheelers was an example of the reverse India consumer story at play. On the positive side, apart from base metals and electricity, HR coils and sponge iron showed growth; but that could be attributed more to a very favourable government policy.

In terms of user-based classification, capital goods continued to show de-growth of (-3%) and that is a clear indication of a delay in the pick-up in the capital cycle. Both consumer durables and consumer non-durables registered negative growth rates of (-10.3%) and (-5%), which can be largely attributed to the side-effects of demonetization.

Why the next couple of quarters will be critical from an IIP point of view…

IIP will remain a key data point over the next few quarters. Here are 4 key takeaways…

• The fourth quarter will determine if the remonetisation has been effective enough to reverse the negative impact on growth.
• A V-shaped recovery may be hard to envisage as in many cases, the damage to businesses and cash flows may be a lot more lasting and hence may take time for a recovery.
• Business will have to contend with the reality that consumer demand may continue to remain tepid due to consumers becoming more conservative on spending.
• The speed of recovery in the IIP will also determine the RBI rate stance. If IIP continues to be tepid, then the RBI may be forced to cut rates more aggressively. In that case 2 more rate cuts of 25 basis points in this calendar year may be on the cards.

It is evident that the pressure of demonetization is showing on the IIP number. The sectors most impacted by the demonetization have exerted the maximum pressure on the IIP in December. The road to recovery, especially in the manufacturing sector, will be critical from here on.