Gap between India's underlying economic growth and IIP set to grow further

The link between India’s underlying economic growth and pace of industrial production continues to weaken. After the latest slump in the index of industrial production (IIP), the gap between underlying economic growth and IIP is set to rise in the January-March 2019 quarter. 

According to the data by the Central Statistics Office (CSO), industrial production was up just 0.8 per cent on average during the first two months of the current calendar year, against an expected 7.3 per cent year-on-year growth in gross value added (GVA) during the January-March 2019 period. 

Economic growth is based on Bloomberg consensus estimates. If the March 2019 IIP was to grow at the average rate of the first two months of the quarter, GVA would outgrow industrial production by 660 basis points (bps). One bps is one-hundredth of a per cent.

The last time a similar, wide gap between underlying economic growth and the pace of IIP was during the June 2015 quarter at 6.4 per cent. In the last 20 years, quarterly GVA growth has exceeded IIP growth by 600 bps or more on only five occasions (on quarterly basis). The first time it happened after the 2008 Lehman crisis and then in September 2012 and June 2015 quarters. 

Experts attribute the dichotomy in industrial production and GVA growth to two factors, namely the difference in calculation method of both indicators, and a steady decline in the manufacturing sector in recent years. 

“Headline economic growth now captures value addition or businesses gross margins, including labour cost rather than production volume. In contrast, IIP measures the changes in production volume,” says Madan Sabnavis, chief economist, CARE Ratings.

Given this, headline gross domestic product (GDP) could continue to grow at a fast clip, driven by lower input costs and higher margins in the corporate sector, even if industrial production remains sluggish. 

“In the current GDP series, changes in prices of key inputs such as crude oil and the resulting variation in corporate profitability have a greater bearing on headline economic growth than actual growth in the production of goods and services in the economy,” says Dhananjay Sinha, head of research, Emkay Global Financial Services. 

The gap between production and growth is clearly visible in the current GDP series, where growth rate is available from the June 2012 quarter. According to the CSO estimates, GVA at constant prices (on quarterly basis) has grown at an average annualised rate of 6.9 per cent since April-June 2012 period, against 3.5 per cent annualised growth in industrial production during the period. 

In comparison, in the preceding five years (FY07-FY12), quarterly GDP had grown at an annualised rate of 8.1 per cent, against 7 per cent growth in IIP during the same period.

Others also highlight the role of a decline in the manufacturing sector and rise in the share of services sector in the overall GDP. “The manufacturing sector’s share in India’s GDP is now at an all-time low, and services now account for well over half the economy. Given this, the economy would continue to grow, even if industrial sector remains stagnant,” says G Chokkalingam, founder and managing director, Equinomics Research & Advisory Services.

Economists, however, say the recent slump in IIP could weigh on growth figures in the forthcoming quarters. “The recent decline in IIP is largely due to slowdown in consumer durables segment and decline in capital goods production. This will have some negative bearing on industrial growth and the overall GDP growth on the forthcoming quarters,” adds Sabnavis.