Economy: Higher IIP growth, lower inflation=higher real output? - Kotak

Higher IIP growth, lower inflation=higher real output? The revision of IIP and WPI series was needed to ensure that they remain in consonance with the current economic activity and with other variables, particularly GVA, which takes inputs from IIP for its imputation. Removing indirect tax component from the WPI will also improve real GVA estimation and reduce the faulty deflator problem to some extent. However, the upward and downward revisions in historical IIP growth and WPI inflation respectively may lead to upward revisions in the national account series.

The new IIP series shows a much higher growth

CSO released the new IIP series (base 2011-12) in an effort to improve coverage and conceptualization of data amid rapidly evolving economic structure, and also syncing well with the present national account series. While at a broad level a total of 839 items are covered from 682 items earlier (with 189 new items added in manufacturing), 33 items have been dropped in mining Importantly, in order to do away with definitional ambiguity in the basic and intermediate goods, the 'basic goods' category has been replaced by 'primary goods'. A new 'infrastructure / construction goods' category has also been added Also, the introduction of 'work in progress' concept will correct for volatility in capital goods whose production have a high gestation period. The new methodology appears to have pushed up the IIP growth than earlier reported consistently for the past few years, mostly led by increase in factory coverage and removal of closed/irrelevant ones. Particularly for FY2017, IIP growth has averaged 5.0% in the new series as against a mere 0.7% in the old base series.

The new WPI series shows a much lower inflation

The new WPI series (base 2011-12), while improving its data quality, further strengthens the quality of IIP data. WPI now aligns its item basket with the new IIP basket so as to have the best possible mapping resulting in availability of appropriate deflator for each item group. Besides, the new WPI series does not include any indirect taxes, which brings it conceptually closer to the producer prices and also removes fiscal impulse impact. The index computation is geometric mean based (like CPI) with marginal changes in the weights of major item groups. However, the new methodology has led to consistently lower WPI inflation than earlier reported for past few years. Particularly for FY2017, WPI inflation has averaged a mere 1.7% in the new series as against 3.7% growth in the old base series.

Bracing for a revision in GVA growth again

The revision of IIP and WPI series was much needed to remain in sync with the GVA. The GVA takes inputs from IIP for its imputation. Removing indirect tax component from the WPI in manufactured goods (~65% weight in WPI) will also improve real GVA estimation, given that GVA doesn't factor in indirect taxes. This will make the process of deflation of current price based value of output data more robust. However, given the significant upward and downward revisions in IIP growth and WPI growth respectively in the new series, there could be recalibration of the GVA series in constant prices terms. This could particularly impact the advance GVA estimate of FY2017, whose dependence on volume based IIP series is relatively higher for proxy estimation of the unorganized sector. The final national accounts series (which comes with a lag of two years) is less dependent on IIP as it includes the ASI data for computation. Additionally, it needs to be seen if the inherent lumpy nature of capital goods (linked to the production pattern) will see some improvement with the new data recording methodology of 'work in progress' concept.

Detailed methodological changes in IIP and WPI series

Given the rapidly evolving nature of the economy, periodic revision of the base year and weighting diagram of the series are needed. There will also be annual review process of items by the technical committee for WPI and IIP.

Methodological changes in IIP

The revision of the base year to 2011-12 will align the new IIP series with other National Account Statistics data series. The new IIP series will continue to use the Output Approach to estimate IIP using the hybrid method of using a mix of physical output quantities and value of output (deflated using WPI). Care has been taken to align the new WPI item basket with the new IIP basket. A move completely towards a volume estimate will require a holistic PPI.

More importantly, given the volatility and data quality issues that have marred the old IIP series, taking cues from the IIP working group committee report, the new series has been constructed keeping in mind factors such as:

- To use the frame available with the ASI and supplement it adequately with the list of factories available from the different source agencies. The selection at more disaggregated level will make the index more representative.

- The sectoral weights have been distributed at 2, 3 and 4 digit levels of National Industrial Classification (NIC), 2008 using GVA figures from ASI 2011-12.

- To synchronize the item baskets of WPI and IIP so as to have the best possible mapping resulting in availability of appropriate deflator for each item group in the new series.

- Specifically for capital goods, the introduction of 'operating work in progress' concept, which will correct for volatilities in some goods whose production have a high gestation period and were mostly covered only at the time of completion in the earlier series.

- Integration of data collection for IIP and WPI for common set of factories to ensure higher reliability of the volume estimate derived from the monetary value of an item at current price by deflating it with corresponding WPI.

- As per the working group report, the reporting unit for all capital goods and some others would be changed from a measure based on quantity to one of value, using the new WPI series with the same base.

- There have also been changes in use-based classification, with 'basic goods' being replaced with 'primary goods' to do away with any ambiguity in basic and intermediate goods. Also, introduction of a new 'infrastructure/construction goods' category to address the linkage of production with infrastructure and construction sector.

- To reflect the increasing significance of electricity generation from renewable sources, a new inclusion is being done from April 2014 onwards as monthly data for electricity generation from renewable sources for earlier months were not available.

Methodological changes in WPI

The major change in the new WPI series has been the removal of indirect tax component from the WPI, making it closer to the concept of the PPI. This will also improve real GVA estimation, given that GVA doesn't factor in indirect taxes. This will make the process of deflation of current price based value of output data more robust. Besides, the new WPI series will also get rid of the fiscal policy impact. The estimation in the new series will also follow the geometric mean methodology in line with the CPI series.

- In manufactured products, the number of 2 digit groups has been increased from 12 to 22 in the new series in keeping with National Industrial Classification (NIC) 2008.

- A new "Food Index" is being compiled combining the "Food Articles" under "Primary Articles" and "Food Products" under "Manufactured Products". Together with the Consumer Food Price Index released by Central Statistics Office, this would help monitor the price situation of food items better.

- The index for electricity in the new series will be compiled as a single item of monthly average rate of sale of power of 49 selected hydro and thermal generating stations. This is in comparison to the separate indices used in the old 2004-05 series according to usage in agriculture, industry, domestic, commercial, and railways.

Data coverage of the March IIP and April WPI new series

Industrial production surges; sees broad-based improvement

The new IIP series (base 2011-12) recorded a higher-than-expected growth of 2.7% in March compared to 1.9% in February and market expectation of 1.9%. Sector-wise, mining surged 9.7% from 4.6% in February, electricity growth increased to 6.2%. Under the use-based category production of primary good largely comprising minerals surged 17% yoy. Capital goods also registered the first positive reading in five months (30.5%). The production of consumer non-durable good, bellwether of rural demand, continued its uptrend (19.5%), and durable goods production registered the first positive reading in five months. The new category of Infrastructure and Construction Goods also picked up sharply by 13% from (-) 8.7% in February.

WPI inflation revamped to 2011-12 base; consistently lower than the old series

Newly released WPI inflation with 2011-12 inched sharply lower to 3.9% in April from 5.3% in March. The fall was largely led by favorable base effect. On a sequential basis, WPI inflation registered (-) 0.2% mom growth as compared to the historical 4-year average of 0.4% seen in April, led by (-)1.9% mom decline in fuel inflation. Notably, the new WPI inflation series is consistently lower than the older series, with all subcategories mirroring similar patterns. However, only in February and March, the fuel inflation has risen higher than the old series.

Source : Equity Bulls

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