While the latest data available for production continues to show signs of a sharp decline in growth, a set of leading indicators suggest that the deceleration may soon be coming to an end. Many of the variables found to lead growth in production, such as trade, credit and business confidence, which have been showing a downturn for most of last year, no longer indicate a further downswing. If over the next month or so, such a trend continues to be observed as data become available for April and May, the economy could well be on its way to higher growth again. As these indicators often lead manufacturing activity by a few months, a pick-up in manufacturing may be observed in the first quarter of 1997-98.
The first step in the construction of leading indicators was to identify growth cycles in manufacturing. The cyclical component was separated from the trend, seasonal and irregular components using simple statistical methods. In the next stage of the analysis, the cyclical pattern of other variables, largely those for which monthly data is available, was used to determine the lead on the IIP (manufacturing). Among the set of business cycle indicators that have been identified as having cycles synchronised with the those in industrial production are bank credit, trade variables like exports and imports and the National Council for Applied Economic Researchs (NCAER) business confidence index. The decline in industrial activity observed since October was led by the downturn in all the selected leading indicators well in advance.
The latest data for most of the above leading variables are available for March 1997. Total merchandise exports and imports, and imports of non-petroleum products, especially imports of chemicals and machines, have been found to have discernible leads over the turning points in manufacturing growth cycles. At peaks, exports are coincident with manufacturing activity while at troughs they lead it. Imports are seen to have a lead of about 3-4 months at peaks and troughs. For the latest data, while exports do not show any further decline, imports, total and non-POL, show an upward movement for the last three months. Disaggregated data for imports of machinery and chemicals is available only till January 1997. However, both have been showing an upward movement for 5 to 6 months now.
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Bank credit as a whole, especially non-food credit and credit to the commercial sector, acts as a leading indicator. As bank credit is primarily needed to finance working capital needs, a decline in credit growth is an indicator of the decline in economic activity. Offtake of bank credit by the firms may slow down either because of dampening of demand for industrial output and consequent curtailment of production plans; or growth of credit offtake may drop as bank credit becomes expensive and the resulting increase in working capital cost may lead to overall increase in the cost of production and a subsequent drop in derived demand for credit. Here, rise in the cost of credit adversely affects not only the cost of production/supplies but also demand for consumer durables and capital goods, leading to a situation where firms are likely to find themselves unable to pass on additional interest cost to consumers. This results in reduced profit margins and hence curtailment of production plans. In sum, credit
offtake slowdown is likely to lead the actual decline in the growth of production.
Non-food credit showed a lead of 10 months to the IIP peak in February 1991. In other words, the cyclical component of non-food credit started showing a downturn after April 1990, ten months before the cyclical component of IIP started declining (in February 1991). The upturn in the cyclical component of non-food credit was coincident with an upturn in the cyclical component in IIP in April 1994. So, while credit starts going down before industrial activity does, it starts going up only with higher activity levels. One reason for this would be that a significant component of bank credit is for short-term transactions.
Bank credit has been showing a downturn since March 1996. This was seen in non-food credit, bank credit to the commercial sector as well as total bank credit. The latest figure no longer indicates a downturn, in fact, it shows a slight upward movement. The credit policy for the busy season of 1996-97 responded to the slowdown by making more funds available by reducing CRR. A softening of interest rates was witnessed by the economy after the busy season credit policy. Nominal rates the 91-day and 364-day bill rates and the prime lending rates (PLR), IDBI lending rate, call money rates, deposit rates etc. experienced a downward trend. If we look at the real PLR (deflated by the rate measured by the WPI), the figures reveal a downward decline in the real rates over the last six months. The reduction in real interest rates, it is hoped, will lead to a pick-up in credit offtake.
Another series that is useful as a leading indicator is the index of business confidence (BCI). NCAER has been conducting periodic surveys of business sector on the state of the economy since 1992. Based on these surveys it has constructed a business confidence index which suggests a measure of optimism of the business sector on the performance of the economy in the short-term. The BCI has been seen to lead the cyclical changes in IIP. For the latest downturn in manufacturing seen since October 1996, the BCI appears to have a lead of about 10 months as a continuous decline in the BCI has been observed since December 1995. The lead for an upturn in production may be different. Results of the latest round of the expectations survey held in May 1997 are expected to show and increase in confidence levels after the investment-friendly budget and credit policy. Further, in the previous round of the expectation survey, held in January 1997, more than 40 per cent of the respondents felt that they were severely
affected by the high cost of capital. The reduction in cost of credit is also expected to improve the investment climate.
The indicators give reason for hope as they seem to show no further signs of a continuation of the deceleration. However, an upturn can be predicted only if all or most of the indicators show an upward movement at least for 2 to 3 months. Bank credit has shown some improvement after data for March came in. Imports have been showing a rise for three months. Imports (non-POL) are expected to have a lead period of about 3-4 months. If the upturn in the leading indicators continues, we can expect to see signs of a pick-up in manufacturing even in the first quarter of 1997-98. Over the next two months as the IIP for the last quarter of 1996-97 becomes available, the growth scenario may appear to be dismal. It is important to monitor the leading indicators. Ongoing research at NCAER involves an analysis of monthly data to examine these variables. It may, however, not be possible to predict accurately when the upturn will take place mainly because the length of the cycle is not uncertain as the Indian economy has
started witnessing cycles only recently and, in an economy in transition, both the length of the cycle and the lead and lag periods are expected to change.
( Ila Patnaik is Senior Economist, National Council for Applied Economic Research, New Delhi)