Core sector growth boosts to 6.6%, second best in last 16 months

The core sector number for the month of October 2016 was announced by the Department of Economic Affairs on 30th November. The core sector consists of 8 key sectors that form the backbone of the economy and include; Steel, Cement Fertilizers, Crude Oil, Natural Gas, Refinery output, Electricity and Coal. The reason the core sector is important is that it constitutes 38% of the index of industrial production (IIP) and therefore tends to lead the IIP with a time lag. More importantly, the core sector number has strong externalities. The increase in production of sectors like steel, electricity and coal has a multiplier effect on the economy. Changes in any of these variables have a proportionately higher impact on the GDP…

How did the October Core Sector number for Oct 2016 pan out?

Monthly Core Sector Growth of 8 key industries in percentage
The core sector number for the month of October came in at 6.6%, which is the second best number recorded in the last 16 months. Of course, a part of the spurt in the core sector number can be attributed to the festival demand which is rampant during the months of September and October every year. We also need to appreciate that, unlike in October 2015; the core sector growth in October 2016 also gets the benefit of the base effect. But what is heartening is that the core sector number has managed to stay in positive territory for a full year now and that is indication enough that the green-shoots of an overall economic recovery are beginning to be seen. More important is the break-up of these core sector numbers to better understand what sectors have driven a spurt in the core sector.

How the components of the core sector performed for October 2016…

Let us first look at the sectors that contributed to the upward thrust to core sector growth. Interestingly, refinery output was a major contributor to the spurt in core sector growth for the month of October. Refinery output showed a sharp spurt of 15.1% for the month of October on a YOY basis, largely on the back of higher refining capacity this year and greater throughput. The other big positive surprise was the steel sector. Steel output increased by 16.9% for the month of October 2016. This increase was across the board and was largely driven by the supportive policy that the government has adopted towards the steel industry to protect it from Chinese dumping risks. Cement production also showed a 6.2% increase for the month of October, although the impact of demonetization will have to be watched closely in the months ahead.

On the negative side, crude oil output was down by 3.2% due to a sustained fall in Brent Crude prices below the $50/bbl mark. However, this situation could change drastically if the OPEC production quota can push crude oil prices up. Natural gas output also fell by 1.4% due to weak global and domestic prices. However, the impact of weak natural gas is not likely to be exaggerated as it only has a weightage of 1.71% in the core sector basket. The big disappointment was coal output which fell by 1.6%. With the pick-up in the power sector, one would have logically expected coal sector to do better but that has not been the case.

Among the remaining sectors, fertilizers increased by a marginal 0.8% and the expectation would have been a much better pick-up due to a normal monsoon and a bumper Kharif crop. Even electricity growing at 2.8% was not encouraging as it comes after quite a few months of consistent pain. We need to see more from the electricity sector for coal demand to pick up meaningfully.

What to watch out for in the coming months?

It is quite clear that the core sector numbers for October 2016 could have been driven by a combination of the base effect and the festival demand. It would be early to conclude whether there is a decisive up-tick in the core sector, but 4 key factors need to be kept in mind…

  • The OPEC has agreed upon a production cut of 1.2 million barrels per day. To what extent this will impact prices remains to be seen. But if crude sustains above $50/bbl then crude and natural gas could expect good times.
  • Steel output has got a boost from protective measures by the government. As a result, user industries may be paying a higher price. To what extent this is sustainable remains to be seen.
  • Demonetization is likely to hit the construction and real estate demand for cement. The pressure on cement output may become more evident in the coming few months.
  • One thing that remains to be seen is how the cash imbalance in the economy will hit the core sector production. While there are no paradigms, trends are already visible of a contraction in demand across industries. That will be critical.

In a nutshell, the core sector is surely encouraging. However, the impact of the liquidity crunch needs to be better understood. That may be the billion dollar question!

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