Interpreting industrial production numbers is tricky at the best of times. The sharp gyrations in the capital goods sector, which accounts for less than 10 percent of the index, has resulted in a wildly oscillating IP index over the past year. This process gets more complicated around Diwali when base effects come into play, as production ramps up before the festive season and retraces thereafter.
Given all this, it's no surprise that the markets have misread the IP print over the past two months. There was premature jubilation when October IP surged to 8.2 per cent. Conversely, there was dismay when the November IP contracted marginally. Equity markets and the rupee weakened by nearly half a per cent upon the news.
Neither market reaction was justified. Year-on-year growth rates in both months were disproportionately influenced by base effects. While October grossly overstated the good news, November grossly understated it.
A much better picture is gleaned from looking at the underlying momentum – examining the seasonally-adjusted, sequential quarterly momentum. The picture is not nearly as bad as is being projected. Instead, the industrial slowing seems to have bottomed in the third quarter, with monthly IP advancing sequentially for consecutive months in October and November, the first time this has happened in two years.
As a consequence, industrial activity is on course for a modest lift in the fourth quarter. This is consistent with what the manufacturing PMIs (purchase managers index) have been telling us for three months. So, there is some method to the madness after all. Once all the noise is stripped away, there is emerging evidence that the worst might be over on the industrial front.
Should this be reason for policy complacency? Absolutely not. It is critical to distinguish trend from level. Though the trend might be getting better, the level to which industrial growth is heading (the new normal), leaves much to be desired. This should come as no surprise. Until binding supply constraints – land acquisition, fuel and raw mineral availability, environmental and policy clearances – are addressed, India will continue to stagnate in the five to six per cent growth range. Only decisive and sustained policy action can boost the economy's growth potential.
Evidence of this was visible in the IP print itself. There is absolutely no evidence that the mining sector is turning around, with November being the seventh month in the last 11 where sectoral activity had sequentially contracted. The troubles in the sector are both a cause and symptom of India's binding supply constraints and, while the government has repeatedly indicated this to be a key focus area, the data is only getting more and more sobering.
The other message in the IP numbers is that consumption is doing much better than investment and capital goods in recent months. So, while the markets might obsess on upcoming Reserve Bank policy, the keys to IP and growth prospects might not lie with RBI. But, instead, with the efficacy of the recently-instituted Cabinet Committee on Investment and the degree to which it can push the supply curve out.