InvestorQ : Why has the latest industrial production turned negative? What does that mean for GDP growth and for corporate sales?
Lavanya Subramanian made post

Why has the latest industrial production turned negative? What does that mean for GDP growth and for corporate sales?

ishika Banerjee answered.
3 years ago

The index of industrial production (IIP) for August 2019 was announced on 11th October at a 7 year low of (-1.1%). Let us see some of the key points that explain the fall in IIP.

· The fall in industrial output to (-1.1%) was a result of a contraction in manufacturing output and a slowdown in capital goods production.

· This represents the worst IIP performance in the last 81 months, and that is a very long time.

· The pressure came from the manufacturing sector. This segment is significant because it accounts for nearly 78 per cent of the IIP. For the month of August 2019, manufacturing output turned negative for the first time in this fiscal year. In fact manufacturing output fell by 1.2% in August. This contrasts with a 4.6% positive growth in manufacturing sector output in the month of July.

· Capital goods segment, an important sub-sector that signifies investment, contracted 21% and was the real reason for the long term worries on IIP. Even in the month of July, capital goods had contracted, but only by 7%. Contraction was 7 per cent in the previous month. Production in the category remained in the red for the seventh straight month.

· From a more practical standpoint, weak capital investment growth is also indicative of less demand for investment and consequent stress on the financial sector. This is evident in the sluggishness in loan off take for industrial purposes.

· Interestingly, 15 out of the 23 sub-sectors within manufacturing showed a YOY contraction in the IIP. No surprises as automobiles and machinery production were down more than 20% on a YOY basis.

· If pressure on consumption is the base of the consumption story, then consumer durables demand can be a good proxy. In fact, consumer goods production was slowing for some time, reflecting inventories that have built up in the third quarter of 2018-19, when capacity utilisation also improved. But, with demand tapering off, production has slowed down.

· Within the IIP basket, construction activity took a sharp hit due to above average and unseasonal rains in the month of August. Construction goods decelerated by 4.5% in August. Electricity generation also fell 0.9% in August. To a large extent, this fall in power generation can be attributed to the strike at Coal India protesting against the proposed introduction of FDI in coal mining.

If one were to sum up these things, it appears like GDP may be under pressure in the second quarter. For example, the RBI has already projected the GDP growth at 5.3% in the second quarter ended September. Even that sounds a tad ambitious at this point of time. But the bigger worry could be the growth in the last two quarters where the RBI is assuming nearly 7% growth in GDP. With the kind of IIP data that is coming in with pressure on consumption and on capital formation, it looks increasingly unlikely.

IIP represents high frequency indicators and the manufacturing output represents nearly 78% of the total IIP. That could pressure GDP in the last two quarters also. That would also impact the top line growth for Indian manufacturing companies in the last two quarters.