Why Doesn’t India’s Red-Hot Manufacturing Reflect in Industrial Output?

Interpreting Indian economic data is difficult even at the best of times. The challenge intensifies when two indicators that ostensibly track similar activity send sharply diverging signals, as in the case of India’s manufacturing Purchasing Managers’ Index and the Index of Industrial Production.

In July, the HSBC Flash India Manufacturing PMI surged to 59.2, a nearly 17-and-a-half-year high, from 58.4 in June. According to S&P Global, which compiles the data, the reading indicated a “robust improvement in the health of the manufacturing industry”. The last time the PMI was this high was in February 2008, when it touched 59.5.

Since the COVID pandemic, India’s manufacturing PMI has consistently remained above its historical average, signalling steady expansion in the sector. Yet, this buoyancy appears at odds with what official factory output data suggest.

Diverging Indicators
India’s IIP, a key indicator of industrial activity, paints a far more subdued picture. In May, industrial output growth slowed to a nine-month low of 1.2%, despite the manufacturing PMI remaining healthy at 57.6. Early estimates for June show only a modest uptick. Output from eight core industries, which account for over 40% of the IIP, grew by 1.7%, up from 1.2% in May.

Within the IIP, the manufacturing sector, which accounts for about 78% of the total weight, fared slightly better, expanding by 2.6% in May. That growth, however, pales in comparison to the optimism suggested by the PMI.

Over the past 10 months, India’s industrial output has grown at an average pace of 3.1% compared with 6.2% in the same period a year earlier. This slowdown has become more pronounced in recent months.

The Disconnect
The divergence is best explained by the fundamental differences between the two indicators. 

The IIP measures actual physical production. In contrast, the PMI is a survey-based indicator reflecting the sentiment and expectations of purchasing managers, and is limited to the manufacturing sector. 

While the IIP reflects volumes of goods produced, the PMI captures whether activity levels are improving or deteriorating compared to the previous month. 

Moreover, the IIP is sensitive to seasonal variations and the base effect, which can distort monthly readings. The PMI, being a month-on-month diffusion index, is relatively immune to such fluctuations but is inherently subjective.

Another factor is timing. The PMI is released within the first few days of each month, providing real-time insights. Even after reducing the time lag in IIP reporting by two weeks, it still trails the PMI by nearly a month.

Does PMI Still Matter?
Despite these differences, the PMI remains a valuable tool. According to a research paper by two Reserve Bank of India staffers, empirical analysis shows a positive correlation between PMI and seasonally adjusted overall and manufacturing IIP.

The study showed that a rise or fall in PMI led to a similar change in seasonally adjusted overall and manufacturing IIP, albeit with a lag. It said the manufacturing PMI was a reliable lead indicator for both overall and manufacturing IIP, at least in the short run. The disconnect is a reminder of how complex economic signals can be.