Capital paradox

Quality and consistency issues apart, it's premature to conclude that a bottom is being reached

The numbers for the Index of Industrial Production (IIP) for January 2009, released yesterday, are along broadly expected lines. The overall index dropped by 0.5 per cent from its level of January 2008, while the manufacturing component, accounting for about 80 per cent of the index, dropped by 0.8 per cent. Along with the significant upward revision to the December numbers, which saw the estimated growth from December 2007 change from -2 per cent to -0.5 per cent, these relatively small negative numbers give the impression of a bottoming out of the decline. Indeed, they suggest that the stringent credit conditions that emerged in October, and contributed to the decline immediately afterwards, have begun to ease and producers are now using low input prices and interest rates to replenish depleted inventories. If this is the case, it is indeed good news for a beleaguered economy and its prospects for the year ahead.

However, the numbers need to be understood in greater detail, and must be interpreted with caution. In the first place, if these numbers were in fact a precursor to a bottoming out, they suggest that the transmission from policy action to economic response is lightning fast. Monetary policy turned pro-growth in October. There was also a significant fiscal stimulus around the same time, as the government paid out a part of the arrears on account of the implementation of the Sixth Pay Commission recommendations. This, it appears, is having some impact. The numbers for consumer durables production have shown an increase, though small, in contrast to the negative pattern seen for this category over the past few months. Perhaps government employees who received their arrears are doing the right thing by the economy and using them to buy new appliances. As the implementation spreads to state government and public enterprise employees, this suggests significant support to some sectors.

On the broader issue of transmission lags, though, the implied speed of the process raises some questions. Of particular interest is the surge in the industry segment Machinery and Equipment, which grew by 17.5 per cent over January 2008. This took the capital goods category to a growth rate of 15.4 per cent, completely against the grain of the past few months. This number is, in fact, reminiscent of the investment boom of a couple of years ago. It would be greatly reassuring to policymakers and investors if machinery production were surging in the current environment. But, in the midst of all the news that is coming in from companies, banks and other players, it stretches credibility.

The aberration is even more striking when compared with the performance of other industry segments. Only five of the 17 showed positive growth. Metal Products and Transport Equipment, both driven by the factors similar to Machinery and Equipment, declined by 4 per cent and 13.4 per cent, respectively, over January 2008. Cotton Textiles declined by 8.5 per cent, as did sectors which have relatively high export content, like Leather and Leather Products. Even Food Processing, typically seen as a relatively stable segment, declined by a huge 16.1 per cent. In short, take away the Machinery and Equipment segment and the decline in the manufacturing sector would appear much more drastic. Quality and consistency issues apart, the conclusion that a bottom is being reached seems premature.