Key takeaways from the September IIP numbers…

The September IIP numbers announced on November 11th came in at 0.7% compared to a negative growth of -0.7% in the previous month of August 2016. Over the last few months, the IIP has been one big missing link in India’s growth story. The CPI has come under control and is closer to the long term average target. The WPI is also into positive territory obviating the risk of deflation setting in. At a macro level, the fiscal deficit and the current account deficit are well within the government targets and the currency chest at $365 billion is sufficient to cover nearly 13 months of imports. In the midst of all this, the prices of oil and other commodities have stayed low for over 2 years providing India with a huge commodity dividend. IIP, however, has failed to grow partly due to supply side constraints and partly due to insufficiency of demand. The latest IIP number needs to be viewed in the light of this macroeconomic scenario.

Key takeaways from the IIP announcement…

  1. IIP at 0.7% is likely to leave the overall annual growth in IIP in the range of 2-3%. That would largely be insufficient to sustain a 7.5% GDP growth. Over reliance on services sector may not be the answer since it is manufacturing that has provided the much needed alpha for Indian GDP growth.
  1. The IIP has fallen from the plane that it achieved in late last year and has oscillated between positive and negative growth ever since. The overall annual IIP growth is likely to be lower than the last 5-year average.
  1. The slight improvement in IIP was largely driven by a pick-up in manufacturing which moved into positive territory in the month of September. Manufacturing accounts for over 80% of IIP and hence has an oversized impact on the IIP number.
  1. The other components of IIP; Mining and Electricity had a mixed performance. While electricity grew by 2.4%, the mining sector saw a negative growth of -3.1%. Of course, electricity has been under pressure due to structural issues and hence a positive growth is good news, especially for the coal sector.
  1. On the positive side, the Hot Rolled (HR) coils and passenger cars propped up the IIP. Steel industry has seen a sharp rise in production due to favourable governmental stance like imposition of minimum import price (MIP) and duties on steel imports from China. With the problem of dumping partially resolved, the Indian steel output has started picking up. Auto has been one of the direct outcomes of the sharp rise in consumption and the additional liquidity in the system is also a reason for that.
  1. Ironically, Medium and Heavy Commercial Vehicles (MHCV) applied negative pressure on the IIP number. This is indicative of pressure on pick-up in economic activity since MHCV demand has a direct correlation to the enhancement of trade and business activity in the economy. Rubber and insulated cables also saw negative growth due to weak capital investment scenario.
  1. The big worry, and that has been the case for the last many months, is in terms of user based growth, capital goods has shown a negative growth of -21%. It has been around this range for the last many months and is indicative that the turnaround in the capital cycle is not happening in a hurry.
  1. The real challenge for the IIP may come from the recent demonetization move by the government of India. The sudden move has crunched liquidity in the economic system and that has had a serious impact on economic activity. At least, markets that function on micro liquidity like trade and transport have taken a big hit. The impact of this move will be felt in the IIP numbers of November and December and hence it will be interesting to see how this pans out over the next few months.
  1. IIP needs to be viewed in terms of the pick-up in corporate top-lines and bottom-lines. The last quarter saw a sharp improvement in the operating performance of most Indian companies as the benefits of cheaper oil started trickling. However, their top-line growth still leaves a lot to be desired and that is dependent on IIP growth. The manufacturing sector, especially, will be looking forward to a rapid pick-up in the IIP in the coming months.
  1. There is a very important link between the IIP number and the GDP growth. In India, services form the chunk of GDP and agriculture is the smallest. Although manufacturing only accounts for about 35% of GDP, it is this sector that actually provides the alpha to the GDP growth. Hence a pick-up in IIP is critical. Currently, India is growing its GDP at around 7.5% and enjoys a 100 bps gap with China. This gap ensures that the risk-on money will find India a more attractive alternative.

The IIP number shows some signs of improvement but it may be too early to call a trend. The big challenge will be how IIP handles the liquidity imbalance in the economy. That could be the acid test!

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