A paradox of weak industrial growth

Electricity generation has outperformed the industrial production index for five months in a row this financial year, even as the broader economy is struggling to grow

The paradox of strong electricity growth and weak industrial growth is difficult to reconcile. For the April to August period in the current fiscal, electricity production, which accounts for 10 per cent of the index of industrial production, grew at a staggering 11.8 per cent. But over the same period, the index as a whole grew by just 2.8 per cent. Slower growth in the manufacturing sector, which carries a weight of 75 per cent in the index, was responsible for dragging the index down. These divergent trends raise the obvious question: who is consuming all the additional power?

A probable explanation for higher electricity generation in the current fiscal stems from less-than-sufficient rainfall. The shortfall has resulted in lower reservoir levels as compared to the previous year which has affected hydroelectricity generation in the months of July and August. A consequence of the weak monsoon is that farmers are dependent on ground water for irrigation purposes to a greater extent. According to Aditi Nayar, senior economist at rating agency ICRA, "This is likely to have manifested in higher demand from the agricultural sector, especially in the northern parts of the country. To offset lower hydroelectricity generation, thermal generation has been high for the last three months. Thermal plants have been operating at higher PLFs (plant load factor) in the June-August period in 2014 as compared to the same months in 2013, partly contributing to the lower coal stocks at some stations." Ratings agency CRISIL notes that with mining sector output expanding by 2.5 per cent in the current fiscal, pressure on coal supplies eased compared to the previous year.

The increase in electricity production is also partially the result of lower transmission and distribution (T&D) losses. Madan Sabnavis, chief economist at Care Ratings, says, "Reforms implemented by state utilities as part of the government's financial restructuring programme have led to a fall in T&D losses. As a lot of production gets lost due to T&D losses, cutting them down has helped improve production levels."

Another explanation for the mismatch between electricity generation and the index of industrial production is that the index actually underestimates the level of industrial production. As the index is based on information collected from big companies, small and medium enterprises are largely kept out of its ambit, limiting its coverage. But as the index comes out on a monthly basis, it is a useful barometer to gauge the health of the economy.

Many believe the Annual Survey of Industries (ASI) is a more comprehensive data set as it covers all units that employ at least 10 workers and use electricity or employ 20 workers but do not use electricity. This means that unlike IIP, ASI covers small and medium industries as well. But while the survey is carried out every year, the results are available with a lag of two years. This leads to a greater dependence on IIP, despite its volatile nature. According to a study by M C Singhi, senior adviser in the ministry of finance, the divergence in per annum growth rates in the manufacturing sector was around 4 per cent from 2000-01 to 2007-08, with the largest deviations observed in wood, leather, rubber, plastic and petroleum production. Going by past trends, the latest survey carried out for 2012-13, which is likely to be released towards the end of the current year, will lead to upward revisions in estimates of industrial production.

However, CRISIL expects electricity production growth to taper in the next few months due to a shortfall in coal supply. In addition, CRISIL says the mining sector could see a drop in production because of the Supreme Court ruling on the cancellation of 214 mines that were allocated between 1993 and 2011. Also, moderation in growth in the second and third quarter of the current fiscal could lower production. Capital goods, an indicator of investment demand, has contracted for two months in a row in the second quarter, indicating absence of investment activities. While the government has cleared investments worth $105 billion, it will take a while to fructify. In the meantime, the consumer durables sector may dampen industrial production further. It has contracted for 11 of the last 12 months, indicating that consumer sentiment still hasn't picked up.

Initial data released by the Central Electricity Authority for September shows electricity production may be aligning itself to the wider weak trend. Electricity generation growth rate slowed to 4 per cent.