Tuesday, April 26, 2011

New IIP Old Problem

The new index for industrial production , or IIP, that is expected to be launched soon has not enthused economists as they expect it to have one major flaw of the old index, month-on-month volatility.

The source of this volatility is largely from the capital goods segment, a flaw that the new index has not addressed.

The reason lies in the way the index has been formulated -- it takes into consideration the end product manufactured by companies, including those products that have a manufacturing cycle extending to a quarter or more.

This results in sharp spikes in months in which manufactured products reach the factory gate while equally sharp dip in other months.

These spikes and dips are not necessarily consistent with the investment or demand patterns in the economy making it difficult for analysts to exclusively rely on factory output numbers given by the IIP.

"The volatility, which has been talked about, will continue to remain in the new index," said a senior official in the department of industrial policy and promotion (DIPP), which collects and processes majority of the data for the index.

"We might improve the data points but we still take the end product into consideration. This will remain in the new index too," he added. The current IIP series is based on data received from 3,900 sources. The new series will get information from around 4,800 sources and the coverage will expand to 300 items from a current 213 items. The base of the index will be revised from the current 1993-94 to 2004-05.

With the increased coverage required for the index, DIPP is also grappling with making the data flow for the expanded index consistent in order to reign in volatility caused by irregular reporting by companies increasing reliance on revised numbers in the current index.

Economists agree that the IIP numbers with the new base and increased data points cannot be taken at face value and that it would require "cautious" interpretation. " The fact is that there is no real solution to the problem as long as the index remains a production index," explains Abheek Barua, chief economist with HDFC Bank .

Barua adds that data, particularly that of capital goods need to be looked at for 3-4 months to arrive at a sustained trend.

For Barua the solution lies in an index measuring sales rather than production. " As long as IIP is not IIS (index of industrial sales) you will continue to have such problems," he adds.

Madan Sabhnavis, economist with Care ratings is also of the view that "lumpiness" and "volatility" will continue to be part of the production index.

" There is no real solution but the fact that we need to have greater restraint and be cautious while interpreting the numbers. Ideally we should take the cumulative trend to come to a conclusion," says Sabhnavis.

DK Joshi, chief economist with Crisil India also favours taking moving averages over months to come to a trend. " One has to take moving averages to come to a trend. This irons out volatility. If the data set explains the volatility then its fine. It is unexplained volatility that creates the problem," says Joshi.

Major industrialised nations like the US provide a host of data points such as surveys of orders, information on plant capacity and electricity consumption to give a comprehensive picture of ongoing industrial activity.

An alternative index measuring manufacturing activity in the economy, analysed even by the RBI, is the HSBC- Markit Purchasing Manager's Index ( PMI) , which unlike the IIP, is based on a survey of companies reporting their order books.

"The PMI not only takes orders but a lot of other things into consideration. Extensive market research goes into creation of the index and efforts are made to ensure consistent sample size," added Barua.
Courtesy: http://economictimes.indiatimes.com/news/economy/finance/old-iip-problem-on-capital-goods-plagues-new-index-too/articleshow/8085884.cms

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