Implications of the IIP number

The January 2017 IIP numbers at 2.3% was sharply better than the market consensus estimate at 0.5%. It needs to be remembered that the month of January 2017 was the first full month after the demonetization drive ended on December 31st 2016. Hence this data is very important in assessing the role of remonetization in bringing liquidity back into the system. Here are 10 key takeaways from the IIP numbers announced for the month of January 2017…

Key takeaways from the January 2017 IIP numbers…

  1. The IIP at 2.3% for the month of January 2017 was sharply higher than the negative IIP growth of (-0.6%) recorded in the month of December 2016. While this can be partially attributed to the remonetization effort of the government, it can also be partially explained by the base effect which had shifted sharply between December and January of the previous year.
  1. The IIP number of 2.7%, by itself, does not signify much. It will be evaluated in the light of 3 other factors. Firstly, the positive IIP must be sustainable at least for the next 3 months for it to be a credible data point. Secondly, the PMI-Manufacturing and the PMI-Services must also stay above the 50-mark and display a consistent expansionist trend. Lastly, for IIP to improve there is the need for demand at the factory level and the consumer level to improve consistently.
  1. Of the 3 key components of IIP viz. Mining, Manufacturing and Electricity; it was the highly weighted manufacturing that contributed substantially to the IIP number. This is where sustenance is crucial. The spurt in manufacturing may be largely due to a spurt in orders due to remonetization and remains to be seen if these flows can be sustained in the coming months once the demonetization imbalance is corrected in the economy.
  1. For January 2017, Mining saw a growth of 5.3% compared to just 1.5% in the corresponding period last year. Manufacturing grew by 2.3% compared to negative growth of (-2.9%) in January last year. Electricity growth slowed from 6.6% to 3.9% but it was obviously manufacturing with its high weight that had the most significant impact on the IIP number for January 2017.
  1. On a se sectoral basis, some clear demonetization stories have emerged as the clear winners. Some of the big growth in IIP for January 2017 has been driven by sectors like cables, HR Coils, minerals and passenger cars. Both cables and minerals benefited from industrial demand post demonetization while passenger cars benefited from a turnaround in consumer demand.
  1. On the negative contributors list, sugar, gems & jewellery and cement played a key role. Sugar saw weak production due to shortage in inputs and high leverage issues. Cement was impacted by the weak pick-up in construction demand. Gems & jewellery actually slowed due to the lag effects of the demonetization that has continued to impact select sectors.
  1. In terms of user-based classification, it was capital goods that showed a sharp revival to 10.7% after being deeply in the negative for the past few months. This is partly the base effect, but also largely the effect of the return of liquidity in the corporate system after the effects of demonetization have started to wane. That is the positive takeaway as is evidenced by the sharp revival in demand for intermediate goods too.
  1. In terms of user-based classification, a very clear trend is emerging in the consumer goods space too. While consumer durables have shown a sharp positive growth, the consumer non-durables continued to show negative growth, which has depressed the overall number. The consumer durables growth at 2.9% can be largely attributed to the demand coming essentially from urban areas, which are already in digital payment mode and the impact of the cash crunch was limited. On the other hand, the consumer non-durables saw (-3.2%) negative growth as the incremental demand is more of a rural and semi-urban phenomenon. These were the segments that saw the sharpest deceleration in demand in the aftermath of demonetization.
  1. What is critical now is the outlook for the IIP from here on. There are a few key requirements if the IIP numbers have to sustain at a positive level. The financial system has gone through a huge liquidity disruption and any such shocks must be avoided in the future so that IIP can sustain. Secondly, demand both at the factory level and consumer level need to revive and sustain at higher levels. The next quarter could be critical to the sustenance of the IIP number.
  1. Finally, what are the implications of this IIP number for the RBI rate stance? We feel that the RBI rate stance may focus more on emerging inflation risks than on growth risks. The MCLR of most banks is already down by 100-110 basis points and transmission since January 2015 is already 100%. There is little, therefore, that rate cuts can contribute towards spurring IIP. As the MPC highlighted in the last policy; their stance on rates in the months ahead is likely to be neutral rather than accommodative. Hence, the linkage between RBI rates and IIP may become increasingly tenuous.

The IIP number has surely come as a whiff of fresh air; coming as it does in the immediate aftermath of demonetization. One will have to see how the IIP pans out as the liquidity imbalance in the system is fully restored over the next couple of months. That will be the real test!

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