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Demonetization Effects on PMI-Manufacturing & Services

05 August 20225 mins read by Angel One
Demonetization Effects on PMI-Manufacturing & Services
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The Purchase Manager Index (PMI) announced each month is a quick barometer of whether the business environment is showing signs of expansion or contraction. Ever since the demonetization process was set in motion in early November, small and large businesses have remonstrated against the negative impact on footfalls and business flows. But the PMI numbers for the month of November were, probably, the first credible indicator of how the demonetization is impacting the business environment.

The PMI is normally viewed with reference to the cut-off benchmark of 50. If the PMI comes above 50, it is an indication of an expanding business environment. On the contrary, if the PMI comes in below 50, it is indicative of a contracting business environment. What matters more than the absolute value of the PMI is the indicative PMI trend. Occasional drifts in the PMI are understandable, but a sustained fall in PMI in the contraction zone is not a good sign. This is more so for an economy like India which held the promise of standing out as the fastest growing economy in the $2 trillion plus GDP club.

How have the PMI-Manufacturing and PMI-Services trended…

The above chart captures the PMI-Manufacturing and the PMI-Services for the Indian economy since April-15. The only sharp exception seems to be the month of November 2016 when the PMI-Services has seen an extremely sharp fall closer to the 46 levels. Let us break-up these two PMIs for November 2016 and look at the underlying drivers…

PMI-Manufacturing comes in marginally lower at 52.3…

The PMI-Manufacturing for the month of November 2016 came in marginally lower at 52.3 compared to 54.4 for the month of October 2016. Of course, the month of October was a 46-month high and therefore some tapering was on the cards. But a break-up of the PMI number reveals that the lower PMI was largely an outcome of the side effects of demonetization. Typically, the PMI manufacturing comprises 5 key components viz. Fresh orders, purchases, actual production, inventory build-up and jobs created. The PMI-Manufacturing is an amalgam of all these factors. The surprising thing about the PMI was that the problem was not so much about fresh orders but about the ability and willingness of industry to execute these orders. 

The demonetization exercise in the month of November has created a large imbalance in liquidity as the value of money impounded is substantially larger than the value of fresh notes issued. This obviously created a liquidity shortfall in the system with banks unable to disburse enough cash in proportion to the notes impounded. As a result most purchase managers went conservative and were averse to locking up too much money in working capital. This impaired the ability of Indian businesses to execute orders and the impact was visible in the form of rising order backlogs that could not be executed. This also impacted production for the month of November.

Services PMI falls sharply to 46.7 for November 2016…

The fall was expected as services are normally more vulnerable to a liquidity crunch and the impact is also immediate. In case of industry, there is a time lag before the crunch begins to show up. That, probably, explains why the PMI-Services fell by 8 points while the PMI-Manufacturing fell by just about 2 points. Within the services space, there was a clear fall in the new business inflows as well as services output. Service charges also saw a sharp fall as a result of the liquidity crunch. What is disappointing for services is that this fall disrupts 16 successive months of services expansion in India.

Within the services space, the major negative impact was visible in 3 business sub-groups; Financial intermediation, Hotels & Restaurants and Renting & Business Services. In the financial intermediation business the NBFCs and MFIs that constitute the last mile for banking, were severely impacted by the liquidity crunch in the economy. Another problem that most service providers faced is higher levels of outstanding business. This is associated with delays in the payment cycle. If the liquidity crunch continues for a few more weeks, then these disruptions in the payment cycle could become a bigger problem for Indian businesses. The only goods news seems to be that the levels of optimism about a pick-up in the services sector over the next 12 months continues to be very high.

Key takeaways from the PMI-Manufacturing and the PMI-Services numbers…

The November PMI numbers are clearly showing the impact of a liquidity shortfall. This is in contrast to the US economy which has shown a visible expansion in PMI Manufacturing and Services in the month of November. PMI has a strong bearing on the eventual IIP and GDP numbers. Rating agencies like Fitch have already warned of full-year GDP dipping to around 6.9%. That would not only impact the sustenance of India’s GDP growth but also take away the big growth advantage that India has vis-à-vis China. The PMI numbers should be taken as an early warning signal of the gradual slowdown in economic activity. The earlier the Indian economy gets its act together, the better!

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