More blip than slowdown

The Index of Industrial Production (IIP) for October 2006 was released yesterday. After the euphoria of the performance of the economy during the first half of the financial year, these numbers have come as a rude shock. In October, industrial production grew by a mere 6.2 per cent, a sharp decline from the double-digit growth of the first half. Even more striking is the dip in manufacturing activity. Ironically, while manufacturing growth slowed sharply, electricity production showed an upturn, growing by over 7 per cent, providing relief to some consumers but not enough to offset the slowdown in manufacturing growth.

The performance of different segments of the manufacturing sector, following the use-based classification, provides some indication of the causes of this unexpected slowdown. The two main contributors are capital goods and consumer goods, but the problem in the case of the former is a high base (24 per cent growth in October 2005). Under these circumstances, the growth of 8.2 per cent in the latest month is quite reasonable. However, a pure "base effect" explanation is not adequate for the pattern seen in consumer goods. These had growth at over 14 per cent in October 2005, but have slumped to 0.5 per cent in October 2006, the decline being precipitated by non-durable goods, which actually declined by 0.4 per cent. However, durables didn't help the cause, having increased by a meagre 2.4 per cent. Such a decline in a festival month and when the monsoons were not a total failure does raise concerns about the sustainability of increasing consumption, which has been such an important driver of growth.

However, any conclusion that this pattern is the first sign of a downturn in the business cycle needs to be avoided, at least on the basis of today's evidence. Both basic and intermediate goods actually showed acceleration in October 2006 compared with the same month of the previous year. Since these categories of goods have widespread linkages with the rest of the economy, their acceleration presumably means that other activities down the line are also picking up steam. Combined with the acceleration in power generation, there are enough, though not necessarily very strong, indications that the momentum in the industrial sector continues. With such mixed signals, it would be premature to read into these numbers any real turn in the cycle. During the last four years, when the industrial sector has been on an unrestrained expansionary path, there have been a number of occasions when monthly numbers have caused unpleasant surprises. It is quite likely that October 2006 will fall into that category. Any pessimism needs to be put on hold until the November numbers are released next month, followed by the corporate numbers for the third quarter.

That is not to argue that the sharp downswing on the stock market over the past three trading days is to be read through the same prism. The market had been over-bought, valuations had become rich, prices were climbing on thin trading volumes, and a correction was therefore more than due. The Reserve Bank's signalling of tighter money on Friday may have been the proximate cause of a change of expectations regarding further runaway growth, but it is clear that there was an underlying nervousness that surfaced in the form of sell orders. This has a positive effect in that it helps break any belief that may have crept in, that the market can only go up. It is possible that more money may be willing to come into the market at lower prices, but that is a different matter.