Explaining Dip in IIP Numbers (Sep 2010 - India)

Explaining Dip in IIP Numbers

“Industrial growth continued to decelerate slowing to a 16 month low of 4.4% in September on account of sluggishness in key sectors” – Business Standard.

IIP or Indices of Industrial Growth numbers are one of the key short term leading indicators of economic health and help form expectation of GDP growth growing forward. It is important to know that reported IIP numbers are calculated as percentage growth over last year.

Current deceleration of IIP number is India to a 16 month low can be accounted to two factors. One is a statistical effect and other one is a structural and strategic effect. The statistical effect could be that current deceleration in on account of high base of last year. Last year increase in IIP was very robust and the base for last year (2009) was the slowdown period of 2008 during which industrial production and other key indicators were exceptionally skewed downwards. So, robust growth of 2009 was on account of low base effect of 2008 and 2010 deceleration is on account of high base effect of 2009. Not much to be read into this statistical effect if this indeed is what is happening.

But there is another and somewhat worrying side to this deceleration. The deceleration in growth could be on account of slowdown in the inventory cycle. Businesses typically like to maintain appropriate inventory levels based on their expectations of future growth and level of demand. Thus the current production numbers are based on future expectation of demand. If businesses are getting pessimistic on future growth in demand, they may like to lower their inventory levels and slow down the production. Lower production means lower IIP numbers and may signal a slowdown in GDP growth going forward. Indian economy is closely integrated to the world economy and expectations formed in the global economy get reflected in domestic indicators although with a lag. If industry is indeed in the process of slowing the inventory cycle, global expectation may have played a part too.

There’s a third angle to this story too, inflation and rate increases may have played a part in slowing down the industrial production too. Inflation is positively correlated to industrial production only if the businesses are able to pass on the inflation to its consumers. There is no empirical evidence on a full pass through of inflation by businesses on a macro level and the level of inflation which is not passed through drags industrial production (as input costs increases and margins become lower). Rate increases by the central bank in the midst of high inflation lets industry to form expectation of further rate increases and thus a slowdown or moderation of growth and thus low demand. It’s a complex and a very tight balancing act for RBI indeed.