The Index of Industrial Production numbers for October, published last Friday, shocked observers who believed that the economy was going through a steady, even if modest, recovery. The overall index declined quite sharply, by 4.2 per cent, over a year ago. Most significantly, the manufacturing component of the index, which accounts for over 75 per cent of the index, declined by 7.6 per cent. This was only partially offset by the unusually high growth of 13.3 per cent in electricity. These numbers reflect a strong and unexpected reversal of momentum and, taken at face value, should send alarm bells ringing through the policy establishment. At one level, it will intensify the pressure on the Reserve Bank of India to reduce rates, particularly since the Consumer Price Index numbers also published on Friday show inflation falling off rather rapidly. At another, slower than anticipated growth in industry will further impede already sluggish tax collections, which will in turn raise doubts about the government's ability to meet the fiscal deficit target. It is, therefore, critical to assess whether this is the beginning of a persistent downturn or just a blip.
The performance of individual industrial groups provides some inputs into this judgement. The two groups that contributed most to the decline in manufacturing are radio, TV and communication equipment (-70 per cent), and office, computing and accounting machinery (-32 per cent). While not particularly large segments, these magnitudes of decline obviously have a bearing on aggregate performance. As regards the former, some analysts have pointed out that a contributory factor is the closure of the Nokia plant in Tamil Nadu. This is an unlikely cause since the Nokia plant's production alone could not have been such a big factor and its output in any case had been declining steadily over the past several months. But even if this is the case, while it represents a permanent loss of output, it does not per se reflect a downturn in the macroeconomic cycle. The sharp decline in the other group could be reflective of a reversal in the recovery, but measurement problems may also be at work. But these two groups apart, the main cause for concern really lies in the fact that as many of 16 out of 22 industrial groups showed a decline in output during October.
This broad-based loss of momentum is something that policymakers must watch very closely, while beginning to think about workable and quick-acting responses, if they are needed. Given the typical October-November turbulence in production, depending on which month Diwali falls in, this may well be a one-off blip, in which case the November numbers will support the moderate recovery view. However, if they also turn out to be bad, a revival plan that has two key components needs to be ready for announcement. One, it needs to lay out steps to further accelerate the investment revival that has been promised through faster clearances and approvals. This will be reinforced at some point by a monetary policy stimulus. Two, it has to find a way to plug the potential fiscal hole that sluggish revenue growth will create. Declining petroleum and fertiliser subsidies as a result of the massive drop in crude oil prices will help, of course, but may not be enough. Disinvestment revenues and expenditure reduction are both going to be important contributors. All in all, the economy may be emerging from the woods, but it can't be taken for granted.
