ExplainSpeaking: What IIP data tells us about the state of India’s economic recovery

Dear Readers,

Last week saw the release of two significant data points about the Indian economy.

First relates to India’s Index of Industrial Production (IIP), which recorded a contraction of 1.6% in January.

The IIP essentially tracks the change in the volume of production in Indian industries. To do this, we take a basket of industrial products and create an index by assigning different weights to different products. We then look at the monthly values of this index and compare it with the index value in the same month last year to arrive at the rate of growth. This rate of growth (positive or negative) in IIP signals India’s industrial health or the lack of it.

To be sure, the January IIP is not an outlier. The IIP has been weak in the current financial year — contracting by over 12% between April and January. In other words, the total number of cars, soaps, shirts and machines etc. produced in India this (financial) year was 12% fewer than last (financial) year. In an economy where we add millions each year to the overall population, this is a significant shock.

Still, at one level, the contraction in January is hardly surprising if the overall GDP growth in the economy is expected to contract by 8% in the current financial year (FY21).

But the contraction does raise a question mark on the robustness of economic recovery that is underway. Moreover, it is important to note that this weakness in IIP is on the base of a contraction (of 0.7%) in IIP in FY20.

There are two ways to classify the basket of products mapped under IIP. The significance of the classification is that it aids analysis of what is working and what is not.

One way to classify is to look at the sectoral composition. As such all products in the basket are categorised under one of three sectors: manufacturing, mining or electricity. The relative weights of these three sectors are 77.6% (manufacturing), 14.4% (mining) and 8% (electricity).

Table 1 | IIP: Contraction on the back of contraction (Source: MoSPI) This turned into a contraction of 0.7% for the full year — i.e. April 2020 to March 2021.

As Table 1, which carries the data for FY21 as well as FY20, shows, the IIP has witnessed a contraction over a base that contracted in FY20. The maximum contraction is happening in the two sectors — manufacturing and mining — which are also the most crucial sectors for creating new jobs. This again underscores why unemployment is such a growing worry for policymakers.

The second way to classify is to look at the use to which this basket of products is put to. As such, there are 6 sub-categories:

• Primary Goods (consisting of mining, electricity, fuels and fertilisers)
• Capital Goods (e.g. machinery items)
• Intermediate Goods (e.g. yarns, chemicals, semi-finished steel items, etc)
• Infrastructure Goods (e.g. paints, cement, cables, bricks and tiles, rail materials, etc)
• Consumer Durables (e.g. garments, telephones, passenger vehicles, etc)
• Consumer Non-durables (e.g. food items, medicines, toiletries, etc)

Table 2: Demand for capital goods leads the IIP contraction in FY21 just as it did in FY20 (Source: MoSPI)

Table 2 gives the specific weights of each sub-group and its relative performance not just in January but also in the April to January period.

The most striking entry relates to the production of capital goods, which are demanded by businesses when they start investing in the economy. It has contracted by 9.6% in January — and that too on the base of contraction of over 4% in January 2020. For the April to January period, the decline is a precipitous 25.6% and that too on the base of an almost 12% contraction in 2019-20. What this trend shows is that, even as late as January, businesses in India were unsure of the economic recovery and, as such, holding back from making new investments.

The other striking number on this table is the almost 7% contraction in consumer non-durables in January. Typically, this is a category that should not see contraction because these products are relatively cheaper and regularly demanded by a huge chunk of India’s population. For instance, the number of people wanting to buy a car (which is categorised as a consumer durable) is much smaller than the number of people wanting to buy a bar of soap or a bottle of edible oil — both of which are categorised as consumer non-durables. A fall of 7% shows that large swathes of India’s population (especially the less well-off) were still holding back their demand as of January. This continuing weakness in consumer demand, in turn, reflects in the demand for intermediate and capital goods.

The other big news of the week was the jump in retail inflation in February. In particular, the worry was the spike in core-inflation — that is, inflation in the prices of goods other than fuel and food items. The idea behind calculating core inflation is that since food and fuel prices tend to fluctuate rather sharply, one can remove them to arrive at a more robust measure of inflation. If core inflation remains low while the headline inflation spikes because of, say, a temporary scarcity of fruits and vegetables, policymakers such as the RBI officials conclude that they don’t need to react immediately.

But the fact that core-inflation is almost 6% — the outer limit of RBI’s comfort zone for headline inflation — puts the RBI in a bind.

Why?

On the one hand, as the IIP data shows, India’s recovery is still iffy. Notwithstanding India’s praiseworthy rollout of the vaccine, the rise of Covid cases since January and the imposition of localised lockdowns might have made things worse.

On the other, inflation is going up — both core and headline (thanks to a rise in food and fuel prices).

The former points the RBI towards maintaining low interest rates while the latter demands it to push them up.

Stay safe!

Udit