Manufacturing PMI Trends lower on the back of Demonetization

It appears like the demonetization had its first visible impact in the form a weaker than expected PMI-Manufacturing for the month of November 2016. From a 22-month high of 54.4 recorded by the PMI-Manufacturing in the month of October, the figure fell sharply to 52.3 for the month of November 2016. Of course, with the number above the 50 cut-off mark, the good news is that order books are still expanding. The only worry here is that this is just the initial impact of demonetization and the situation could actually worsen a couple of months down the line if the liquidity imbalance is not addressed on top priority.

How did the Manufacturing PMI perform in November 2016…


The PMI-Manufacturing essentially reflects the optimism of the purchasing managers in the manufacturing sector. This, therefore, becomes a very important lead indicator for corporate results in the next quarter as well as for the index of industrial production (IIP). The 50-level is considered to be the cut-off for the PMI. A level of below 50 indicates that the fresh orders are contracting while a PMI of above 50 indicates that the fresh orders are expanding. Over the last 20 months, India’s manufacturing PMI has been above 50 on all the months except in the month of December 2015, when there was tremendous pessimism and uncertainty ahead of the first rate hike by the Fed in 8 years. The November PMI-Manufacturing at 52.3 was largely impacted by the demonetization exercise which has squeezed liquidity in the market resulting in a more cautious approach from manufacturing companies. The focus at this point will be more to consolidate operations, conserve cash and to take up new projects very carefully. The longer the liquidity uncertainty lasts, the deeper the impact is likely to be on the Manufacturing sector.

Breaking down the PMI number for November 2016…

The big worry in the month of November was that the pace of new orders considerably slowed down. The 3 key factors in the Manufacturing PMI viz. Order Books, Buying Levels and Output saw pressure. New business flows took the biggest hit during the month as there was a tremendous shortage of cash in the financial system. While the banks have already impounded old notes worth Rs. 1,100,000 crore from the households and businesses, the fresh issue of notes has been less than 20% of the notes impounded. This has created a huge liquidity imbalance in the system and that is showing up in the form of weaker order flows and monetary tightness among businesses.

The impact of the sudden withdrawal of bank notes had a visible impact on manufacturing. It created problems for manufacturers as new work was hampered by cash shortages. Also, banks had their hands full due to transaction business and hence normal lending activities took a back seat. This also impacted the manufacturing activity. The demonetization exercise had one positive outcome. Cost inflation seems to be coming under control. However, if the cash crunch persists for too long, then deflationary pressures cannot be ruled out. That is something the Indian policy makers will have to watch closely.

How other key economies fared in terms of PMI-Manufacturing…

To get a better perspective on the Indian Manufacturing PMI, we also look at the Manufacturing PMI reported by two of the largest economies in the world; China and the US. This comparison becomes significant as India currently enjoys a GDP growth advantage over China. However, leading rating agencies like Fitch have already projected that India’s GDP growth for 2016-17 could fall to below 6.9% due to the collateral damage caused by demonetization. India needs to ensure that this advantage is not conceded to China.

So, how did the US PMI perform? US Manufacturing PMI for November came in sharply higher at 54.1. This is the fastest rise in output for the last 20 months and the order books are showing a sharp improvement. Buying of inputs has also increased across US industry. With Trump likely to give a big boost to US industry through his tax cuts and his $1 trillion infrastructure investment program, the impact could become sharply positive in the coming months. The US is seeing rising domestic demand for goods from consumers and businesses and this promises a virtuous cycle for the US economy.

China Manufacturing PMI has also been fairly positive for the month of November 2016. Of course, the PMI-Manufacturing at 50.9 was slightly lower than 51.2 recorded in the month of October. But, October was a 27-month high and some correction was actually warranted. What is important for China is that the PMI has been encouraging for 3 months in a row and depicts the best sustained period for Chinese manufacturing since 2014. Both new orders and output expanded in November although the pace slackened compared to October.

For India, it is essential to ensure that the cash crunch caused by demonetization does not impact the PMI-Manufacturing in a very big way. Normally, cash crunch tends to have a cascading impact on output and jobs. India needs to be careful to avoid this trap.

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