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What is Index of Industrial Production (IIP) ?
In an earlier Jargon Buster article, we discussed GDP and its composition in some detail (Click Here). IIP is a zoomed in view of one of the 3 components of GDP - it measures growth in the industrial sector. Index of industrial production (IIP) is one of the essential short term indicators of the industrial activity in an economy. Index of Industrial production conveys whether the industrial output of a country has increased or decreased and to what extent with respect to a fixed base reference. A shrinking IIP is unfavourable to the overall GDP of a country while a rising IIP suggests that the industrial activity is expanding and capacity addition is taking place in the economy.
IIP data is released every month in India. Office of Economic Advisor, Ministry of Commerce and Industry released the first estimate of Index of Industrial Production officially with the base year 1937 covering 15 important industries. After many revisions, the base year currently stands at 2004-05. Over time, the items that are included in computing this index and their relative weights have been changed many times.
To arrive at the IIP estimate, data is accumulated and sourced from as many as 15 agencies like Central Statistical Organization, department of Industrial Policy and Promotion etc. As more data is made available and responses are received from the manufacturing and other units, the estimates are revised twice subsequently.
In computing the IIP, production data across 543 items that are grouped into 287 item groups is taken into consideration and appropriate weights are assigned to reflect a representative index. These are then broadly clubbed into 3 main categories - mining, electricity and manufacturing. Mining and electricity are seen as the enablers of manufacturing - and as such, are very important for growth in overall industrial activity - which in turn impacts overall GDP growth.
IIP can also be classified on a "use" basis. A 'Use based classification' classifies items used in computing IIP into Basic Goods, Capital goods, Intermediate goods, Consumer durables and Non-consumer durables.
IIP's importance for our stock markets
We have observed in our Jargon Busters article covering GDP and its composition (Click Here), that industry accounts for only 18% of India's GDP - one of the lowest among all large countries. It should have therefore followed that industrial activity would have a relatively muted impact on our stock markets, and that services (65%) and agriculture (17%) would also play a very important role in terms of being a barometer for growth as far as stock markets are concerned.
However, the facts are quite different. Large parts of Indian agriculture remain in the unorganised sector and are not corporatized. Same is the case with many services, which have remained unorganised and relatively small scale and localised - and therefore not corporatized. Lack of corporate culture means no access to equity markets. This perhaps explains why out of the 30 stocks that make up the BSE Sensex, as many as 23 are manufacturing companies. Of the remaining 7 which are banks, IT companies, a telecom services provider and a housing finance institution, one can argue that banks do get sizeably impacted by the underlying manufacturing activity that they lend to. One can thus see that with only an 18% weightage in the overall GDP, industrial activity wields a disproportionately large influence on stock markets as the industrial sector has far many more listed entities than the other 2 sectors.
Trends in IIP
The graph here shows annual growth rate of Indian IIP from 1995 to 2013. Those of us who track stock markets over the years will notice a very sharp correlation between trends in IIP and long term trends in the stock market.
The period 1996-1997 saw a sharp deceleration in IIP growth, and we know this was quite a bad phase for the stock markets. A sustained upward momentum in IIP growth rates is clearly visible from 2003 onwards and this peaked at a massive 20% growth rate in some quarters in 2007. This also coincided with one of the biggest equity bull markets we have seen in recent history. IIP skidded sharply thereafter in 2008 and bounced back in 2010, only to fall back sharply in 2011. The stock market pretty much mirrored this movement. Since 2012, although IIP growth rates are still very muted, we can see an upward trajectory in the direction of the growth chart. This should perhaps give us some comfort that though growth in industrial activity is still nowhere near what we saw in the 2005-2007 phase, at least the direction now seems to be upward rather than downward.
What's dragging down our IIP?
As we observed earlier, IIP is normally sub-divided into 3 broad categories : mining, electricity and manufacturing, with mining and electricity being seen as enablers of manufacturing activity. Their relative weightages in the IIP are as follows : mining (14.2%), electricity (10.3%) and manufacturing (75.5%). Recent trends in the 3 components of IIP are depicted in the graph below.
As is evident, the 2 key enablers - mining and electricity - have slowed down very sharply and there is no evidence of any turnaround yet in the growth rates of these enablers. Hobbled by this, manufacturing growth seems to be presently stuck in a slow growth mode, although it has moved up from the de-growth phases of 2011 and 2012. For the blue line (manufacturing) to start moving up more purposefully, it will need much more support from its two enablers, which continues to be lacking. The ban on mining activities in several states following corruption scandals is clearly showing up in the mustard line's progress, while all the issues surrounding coal availability has clearly impacted the green line, as India does depend quite substantially on thermal sources of power. For a sustainable move upwards, we will need these 2 key enablers of industrial activity to move into a higher gear quickly.
Share your thoughts and perspectives
Do you have any observations or insights or perspectives to share on this issue? Did this help you understand the topic better? Do you disagree with some of the observations? Please post your comments in the box below ..... it's YOUR forum !
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