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Capital goods led IIP growth runs out of steam

by Mahesh Vyas

The index of industrial production in March 2018 was 4.4 per cent higher than it was in March 2017. This growth rate is much lower than expectations, which had averaged at 5.9 per cent before the official estimates were released. It was also much lower than the y-o-y growth rates seen in the preceding four months. The average growth rate seen in the past four months was 7.6 per cent.

IIP’s y-o-y growth rates had shot up suddenly in November 2017 and because they had remained elevated, they understandably raised hopes of sustained higher growth rates. Its muted performance in March is therefore disappointing as it somewhat belies hopes of a revival in industrial activity.

The decline in IIP growth is visible across most major segments. Except consumer goods, all major segments witnessed a slowing down. There was an apparent loss of momentum built over the past four months that was across the board.

Much of the disappointment centres around the performance of capital goods. It was capital goods that had propelled the IIP with its double-digit growth rates since December 2017. In March, capital goods flipped with a 1.8 per cent y-o-y fall.

Capital goods has a weight of only 8.22 per cent in the IIP. But, it is prone to substantial variations and can therefore influence the overall growth rate. Within capital goods it is commercial vehicles that has the largest weight, an 11.5 per cent share of the total weight of capital goods. If we add tyres & tubes for commercial vehicles and bodies of trucks, lorries and trailers - all related, then the combined share of heavy commercial vehicles in capital goods goes up to 18.3 per cent.

Production of commercial vehicles has clocked a growth of 30-40 per cent y-o-y between December 2017 and February 2018. Production of the associated bodies more than doubled in the same period. These two have been the biggest contributors to the recent growth in the capital goods index. The y-o-y growth in these declined a bit in March. Tyres for commercial vehicles posted positive growth in the past four months after having posted negative growth for several months before that. It therefore also contributed significantly to the recent growth. But, these falls in growth rates alone do not fully explain the fall in output of the capital goods industry in the month.

The fall in capital goods in March is spread out across many products. The number of products recording a y-o-y decline increased to 32 compared to an average of 27 in the preceding seven months.

Further, most products of the capital goods group recorded a substantial slowing in their y-o-y growth rates in March compared to the growth seen in the preceding three months. For example, nine of the top ten products in the capital goods industry, accounting for nearly half of the total weight in the group, recorded a lower growth in March compared to the average growth during the preceding three months.

Why would companies suddenly pullback on production at the end of a financial year after being in an accelerated mode for the preceding three-four months? Possibly, demand did not keep pace with the recent acceleration in output and this could have led to substantial inventory build-up. Further, a slowdown in fresh orders could have warranted a reining in of the growth rates.

Raw material costs are rising and if demand was rising, it would make sense to produce in advance rather than later when input costs could be higher. If producers choose to pullback under these conditions, it could only be because of lower-than-expected growth in demand.

If the above is true, then the capital goods led momentum in the IIP may see a pause before it recovers.

The capital goods index reported a small acceleration in 2017-18 to 4.4 per cent from 3.2 per cent in 2016-17 and even lower in the earlier year.

However, this acceleration is not entirely convincing. A large part of this is due to the sprint during December 2017 through February 2018. And, five of the 12 months of the year reported negative y-o-y growth rates. More capital goods product recorded a fall in output in 2017-18 than in 2016-17.

Audited financial statements of non-finance companies show a sharp fall in the growth in net fixed assets in 2016-17. At 6.7 per cent this was the lowest in 13 years. Adequate data are not available yet for 2017-18, but CMIE’s CapEx database does not show any pickup in new investment projects. In fact, these were the lowest in the last 13 years.

Apparently, it will take a little more evidence to repose confidence in a capex pickup.