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The IIP, inflation and RBI story of Indian economy
Read more on - Polity | Economy | Schemes | S&T | Environment
- What IIP does: The Index of Industrial Production (IIP) tracks the change in the volume of production in Indian industries (not the value). To do this, a basket of industrial products is defined, and an index is created by assigning different weights to different products. Then the monthly values of this index are checked, and compared with the index value in the same month last year, to arrive at the rate of growth. This rate of growth (positive or negative) in IIP signals India’s industrial health or the lack of it. The IIP contracted by 1.6% YoY in January vs positive growth of 1.6% in December 2020.
- Jan 2021 data: The January IIP is not an outlier, as IIP was weak in the financial year '21, contracting by over 12% between April and January. In other words, the total number of cars, soaps, shirts and machines etc. produced in India this (financial) year was 12% fewer than last (financial) year. In an economy where we add millions each year to the overall population, this is a significant shock. Still, the contraction in January is hardly surprising if the overall GDP growth in the economy is expected to contract by 8% in the current financial year (FY21).
- Question: The contraction does raise a question mark on the robustness of economic recovery that is underway. Moreover, it is important to note that this weakness in IIP is on the base of a contraction (of 0.7%) in IIP in FY20.
- Technical details: There are two ways to classify the basket of products mapped under IIP. The significance of the classification is that it aids analysis of what is working and what is not.
- One is to look at the sectoral composition. All products in the basket are categorised under one of three sectors: manufacturing, mining or electricity. The relative weights of these three sectors are 77.6% (manufacturing), 14.4% (mining) and 8% (electricity). The IIP witnessed a contraction over a base that contracted in FY20. The maximum contraction is happening in the two sectors — manufacturing and mining — which are also the most crucial sectors for creating new jobs. This again underscores why unemployment is such a growing worry for policymakers.
- The second way to classify is to look at the use to which this basket of products is put to. As such, there are 6 sub-categories:
- Primary Goods (consisting of mining, electricity, fuels and fertilisers)
- Capital Goods (e.g. machinery items)
- Intermediate Goods (e.g. yarns, chemicals, semi-finished steel items, etc)
- Infrastructure Goods (e.g. paints, cement, cables, bricks and tiles, rail materials, etc)
- Consumer Durables (e.g. garments, telephones, passenger vehicles, etc)
- Consumer Non-durables (e.g. food items, medicines, toiletries, etc)
- The most striking entry relates to the production of capital goods, which are demanded by businesses when they start investing in the economy. It has contracted by 9.6% in January — and that too on the base of contraction of over 4% in January 2020. For the April to January period, the decline is a precipitous 25.6% and that too on the base of an almost 12% contraction in 2019-20. What this trend shows is that, even as late as January, businesses in India were unsure of the economic recovery and are holding back from making new investments.
- Consumer non-durables: The other striking number is the 7% contraction in consumer non-durables in January. Typically, this is a category that should not see contraction because these products are relatively cheaper and regularly demanded by a huge chunk of India’s population. For instance, the number of people wanting to buy a car (which is categorised as a consumer durable) is much smaller than the number of people wanting to buy a bar of soap or a bottle of edible oil — both of which are categorised as consumer non-durables. A fall of 7% shows that large swathes of India’s population (especially the less well-off) were still holding back their demand as of January. This continuing weakness in consumer demand, in turn, reflects in the demand for intermediate and capital goods.
- Inflation up: There was a jump in retail inflation in February 2021. The worry was the spike in core-inflation — that is, inflation in the prices of goods other than fuel and food items. Since food and fuel prices tend to fluctuate rather sharply, one can remove them to arrive at a more robust measure of inflation. If core inflation remains low while the headline inflation spikes because of temporary scarcity of fruits and vegetables, policymakers such as the RBI officials conclude that they don’t need to react immediately. But the fact that core-inflation is almost 6% — the outer limit of RBI’s comfort zone for headline inflation — puts the RBI in a serious bind.
- Hobson's choice: As the IIP data shows, India’s recovery is still very tentative. The rise of Covid cases since January and the imposition of localised lockdowns might have made things worse. And inflation is going up — both core and headline (thanks to a rise in food and fuel prices). So a shrinking IIP needs the RBI to maintain low interest rates, while a rising inflation wants RBI to push them up. What will Mr. Das choose to do?
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