What’s brought about the deep crisis in manufacturing?
Business Line
CP Chandrasekhar/Jayati Ghosh
The slowdown in registered manufacturing draws attention to
the structural crisis afflicting the Indian economy, which is both generalised
and deep shrink in
demand, Driving down
growth and Sectors’
movements.
With the
Index of Industrial Production (IIP) registering negative month-on-month annual
rates of growth over the three months ending October 2019, the perception —
based on trends in individual industries — that the Indian industry is
experiencing or is on the road to a recession has gained strength.
It is
true that month-on-month growth rates tend to be volatile and are heavily
influenced by the base effect. However, trends depicted in Chart 1 suggest that
growth decelerated sharply for some recent months before turning negative.
Moreover, even the growth of 0.5 per cent during the first seven months of this
financial year (April to October) relative to the corresponding period of the
previous year points to medium-term stagnation, from which trajectory growth
has moved into negative territory.
Chart 1
also shows the contribution made by manufacturing to changes in the overall
index — computed as the change in the overall index resulting from changes in
the manufacturing IIP alone, after accounting for the weight of manufacturing
in the overall index (the change in the manufacturing index in any month relative
to that index in the corresponding month of the previous year is multiplied by
the weight of manufacturing in the overall index, and then divided by the
aggregate IIP in the base year).
The IIP
is predominantly driven by changes in the index for manufacturing, because of
lower weights for electricity, gas and water supply. As is widely acknowledged,
movements in the IIP reflect trends in in the registered manufacturing sector,
since coverage of the index is restricted almost solely to registered firms.
So, the negative growth in that index in recent months suggests that the crisis
that has afflicted agriculture for some time and had overwhelmed the informal
and unorganised manufacturing sector in the aftermath of demonetisation, has
now spread to the corporate sector.
Analyses
of the current industrial slowdown have emphasised the role of demand factors
in driving the downturn. Defaults on large loans, provided to corporate houses
during the credit surge that began in the mid-2000s; the failure of small and
medium businesses, adversely affected by demonetisation, to meet their debt
servicing commitments; and a crisis in the non-banking financial sector,
overexposed to an unsustainable boom in housing, real estate and automobile
markets, have combined to cut off credit flow and shrink the demand that it
fuelled.
Meanwhile,
government expenditure has contracted because of falling revenue growth and an
obsessive commitment to a conservative fiscal stance, weakening another
important stimulus to growth. The resulting growth slowdown has further
worsened the situation, by increasing the probability of default and adversely
affecting the revenues mobilised and expenditures undertaken by Central and
State governments.
With this
combination of factors dampening demand, the crisis in the manufacturing sector
is proving to be generalised. Initially, with the credit pipe getting clogged
because of accumulating NPAs, the crisis was most visible in sectors like
automobiles and real estate, which depend heavily on debt-financed demand.
Chart 2 shows the extent to which the overall industrial slowdown was the
result of a deceleration of growth in the automobile sector (with its
contribution calculated in the same manner done for manufacturing above).
There are
three features of note in the contribution of these sectors to the overall
movements of the IIP. First, changes in motor vehicles production dominate the
influence of this sector on movements in the overall IIP, with ‘other transport
equipment’ playing a much smaller role.
Second,
the contribution of the motor vehicles product group to overall changes in the
IIP (both during periods of boom and of deceleration) is substantial, varying
between a positive 7 per cent and a negative 9 per cent.
Finally,
before the recent deceleration and subsequent negative growth of the motor
vehicles group, that sector had contributed hugely to an acceleration in
industrial growth, as captured by the IIP. That boom seems to have occurred in
the immediate aftermath of demonetisation, starting around the middle of 2017
and lasting for more than a year, before the slump began.
This
boom-bust cycle following demonetisation could possibly be the result of
changes in bank lending behaviour. Demonetisation resulted in a large increase
in bank deposits, when citizens were required to deposit all notified “high
value notes” with banks, but could only take out a limited amount by way of new
notes.
Since
lending to industry and infrastructure was already excessive and there were
clear signs of mounting NPAs, banks possibly turned to retail lending, in which
automobiles is the second most important component after housing, as well as
lending to NBFCs.
This
possibly triggered the post-demonetisation boom (delaying the full realisation
of the measure’s adverse effect) till overexposure and a tighter credit
environment shrunk credit to that sector, squeezing demand. This has now gone
to an extent where the motor vehicles group is a dominant driver of the
industrial slowdown.
While
trends in automobiles point to the important role that credit has played in
both driving growth and unleashing recessionary trends, the evidence elsewhere
points to the industrial slowdown being more generalised and being affected by
factors other than credit. Chart 3 tracks the contribution of three varied
sectors (textiles, non-metallic mineral products and machinery and equipment)
with significant weight in the IIP, to the overall change in the index.
What
emerges is that all these sectors have contributed to the negative growth in
retcent months. The contribution of textiles to overall growth has been low in
general, but it too shows similar movements in terms of contribution as the
other two sectors.
The
largest contribution to the declines in growth is from machinery and equipment,
followed by non-metallic mineral products.
Interestingly,
the machinery and equipment sector too appears to have gone through the
boom-bust cycle seen in the case of automobiles (and possibly real estate).
This is unlikely to be the direct effect of credit, but rather because of the
cyclical movement in the derived demand for this sector.
Overall,
the generalised nature of the recession suggests that other factors, such as
the contraction in public spending, have now kicked in as factors slowing
demand and industrial growth, thereby intensifying the crisis.
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