The contraction in the latest IIP numbers and the surge in inflation in April have raised question marks over growth prospects of the country. What lies ahead for the Indian economy?
CLI in ‘recovery' mode
A good lead indicator of the pulse of the economy is the OECD Composite Leading Indicators (CLI). This OECD Index is designed to signal the level of economic activity towards which a country is headed, about six months in advance.
For example, back in February 2009, when pessimism was still high in the air, the CLI pointed to a possible trough in economic activity in India, indicating the beginning of an upswing. This indeed played out later in 2009-10. Similarly, the latest report (March 2012) points out that India is currently at a ‘turning point' in economic activity, implying that the slowdown is bottoming out. This is substantiated by steadily rising index points in the last six months. From about 97.8 points in October 2011, the index has moved to 98.9 points in March.
With ‘100' remaining the long-term trend line, a CLI below 100 but progressively rising, denotes that an economy is in the recovery stage. It can be expected to move into the ‘expansion' zone (that is, reading above 100) soon, if this trend continues.
Promising PMI
Another lead indicator is the HSBC-Markit Purchasing Managers' Index (PMI).
Surveying purchasing executives in about 850 manufacturing and service companies in India, this number captures the trends in parameters such as new order flows, stocks of items purchased, backlogs of work, employment levels and suppliers' delivery times.
Hence, unlike the Index of Industrial Production (IIP) which reflects the on-the-ground production levels, the PMI is designed to indicate industrial activity in advance. 50 points is the line that differentiates expansion (>50) from contraction (<50).
The manufacturing PMI posted 54.9 points in April 2012, slightly higher than the 54.7 points recorded in March.
Though the PMI has declined since the January peak of 57.5 points, sub-components of the survey indicate that growth prospects remain good.
For instance, the survey points to new business orders increasing since December 2011. Export orders too remain strong.
The PMI has contracted from the peak only because of constraints such as power cuts and raw material shortages. Hence, while the demand has been robust, infrastructure bottlenecks have prevented the companies from taking full advantage of this.
In fact, the slowdown in demand, as reflected in the PMI index, seen last year has gradually been wearing off from as early as October 2011 itself.
Improved demand has also seen employment levels in the manufacturing sector go up in each of the last four months, putting an end to the period of job losses seen in 2011.
The PMI of service industries too point to similar trends. Although lower than the January peak of 58 points, the services PMI expanded to 52. 8 points in April, up from 52.3 points in the previous month.
Besides, in the latest round of survey, service sector managers have yet again expressed positive sentiments on their outlook for business activity in the forthcoming months. They anticipate higher activity levels in the next one year, taking the degree of optimism to the highest in ten months.
Challenges remain
While these indicators point that India may be back on the high growth path soon, the road ahead is not without challenges. For one, if capacity and infrastructure constraints are not addressed, it will lead to slower order executions, putting brakes on the pace of growth.
The manufacturing PMI survey already points to increasing backlog of work in the last few months, despite sustained rise in employment levels to meet the growing order books.
The second deterrent to growth emanates from inflation. Again, both the PMI surveys point to cost inflation. The survey of manufacturing companies says that the cost inflation in April was the strongest since August 2011.
A depreciating rupee only puts more pressure on input prices by making raw material imports costlier.
While companies have been able to pass on rising prices to customers so far, how much more they can, before it begins affecting demand, remains to be seen. If interest rates begin moving higher again, it will make things more difficult.