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01 Sep 2017 8:24 PM, Insights Mahesh Vyas

Poor demand main cause of low growth in manufacturing sector

Companies struggle to pass on input cost burden; suffer steep fall in profits in Q1

The Chief Statistician’s explanation that manufacturing sector’s fall in GVA growth rate is because of de-stocking following GST is untenable. Inventories of non-petroleum manufacturing companies did not fall during the quarter ended June 2017. And, while inventories of all manufacturing companies put together did fall during the quarter, this fall was not extra-ordinary. But, the fall in the manufacturing sector’s GVA growth is extra-ordinary. There has been a steady fall in the manufacturing sector’s growth. But, the fall in the June 2017 quarter was the steepest in a long time.

The main reason for the fall in GVA growth of the manufacturing sector was a fall in profits. It was not inventories.

We infer this and other related nuggets of information from the financial statements of 1,127 listed companies. This is the sample of companies for which information was available on September, 1, 2017 for the quarter ended June 2017 and also correspondingly for June 2016.

Profit before taxes of these companies fell by 27.9 per cent over their level a year ago. Profits is the biggest component of the gross value added by companies during the June 2017 quarter. It accounted for 37 per cent of the total gross value added by this sample of companies.

Profits declined in spite of a 12.8 per cent increase in net sales. However, expenses grew at a faster clip of 13.1 per cent. This was led by a 14.2 per cent increase in expenses on raw materials. Apparently, demand was too weak to absorb entirely, the increase in costs. For example, cotton textiles industry is finding it hard to deal with high cotton prices and a strong rupee and the automobiles industry is unable to pass-on entirely, the recent increase in steel prices to its customers.

We know from news reports that companies were trying to push sales at the old indirect tax rates for a variety of reasons. There were reports of discounts on sales as well. In spite of these efforts the increase in sales could not entirely offset the increase in expenses and, profits declined.

Apparently, demand was lukewarm during the quarter ended June 2017.

We know from CMIE’s Consumer Pyramids Household Survey that consumer sentiments have been low and they have been falling. The index fell from around 100 (base: 100 in September-December 2015) in April and May this year to around 96 in June and July. In August the index fell to 94.5.

If demand growth is muted and consumer sentiments are low then prospects of a revival in demand during the ensuing festive season are not high.

Transitory disruptions caused by GST only add to the hurdles to a revival. But, neither GST nor de-stocking is the main cause for the fall in the growth in manufacturing GVA.

The main problem is a secular decline in the growth rate since its recent peak in December 2015. This declining trend was only exacerbated by the supply-chain disruptions caused by demonetisation and the initial confusions in the introduction of GST.

We know that there are no new supply hurdles from traditional sources. Government efficiency is high, electricity availability is at its best in recent times, there are no raw material availability constraints such as in gas or iron ore or coal, etc. Interest rates have not been rising and the direct tax regime has been benign.

Industry has sufficient slack capacity as is evident from the 74.1 per cent capacity utilisation seen in RBI’s OBICUS surveys.

A revival in domestic demand is critical to bring back robust growth rates in the manufacturing sector.