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Key Takeaways From the PMI Numbers for December 2016

05 August 20225 mins read by Angel One
Key Takeaways From the PMI Numbers for December 2016
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The PMI (Purchase Manager Index) is a classic measure of whether the particular segment is seeing an expansion or a contraction. Markit Economics calculates this PMI for manufacturing and services separately for all major countries on a monthly basis and announces it in the first week of the next month. For the month of December 2016, India has seen a distinct contraction in manufacturing and services PMI. The chart below captures the trend of PMI manufacturing and services for the last 21 months…

 

Key takeaways from the PMI Numbers…

 

  • The PMI represents the expansion or contraction in that particular segment. Number 50 is considered to be the cut off for the PMI. A PMI number above 50 is considered to be a sign of an economic expansion while a PMI number below 50 is considered to be a sign of contraction.

 

  • A cursory glance at the above chart over the last 21 months clearly indicates that the PMI for manufacturing and services has been above the 50 cut-off for a majority of the months. However, post the demonetization exercise undertaken in November, there seems to be a distinct tendency for the manufacturing and services sector to slow down. It is only at the peak of the Lehman crisis in 2008-09 that PMI stayed below 50 for an appreciable period of time.

 

  • Why is demonetization important to the entire PMI calculation? PMI is a function of robust demand, which in turn is a function of availability of sufficient liquidity. Many key sectors like cement, construction, retail, financial services, FMCG and automobiles got impacted due to the cash crunch caused by the demonetization. That is likely to have a spill-over impact in the next few months. It is in this background that the PMI for December 2016 needs to be understood.

 

  • The PMI Manufacturing for the month of December 2016 came in at 49.8. In fact, it is for the first time in more than a year that the PMI-manufacturing has dipped below the 50-mark. The PMI numbers for January and February 2017 will become more critical at this juncture as it needs to be seen if the impact of the demonetization is spilling over to the New Year also.

 

  • PMI Manufacturing essentially consists of four components. It includes new orders, actual output, inventory build-up and payroll additions. Inventory build-up and payroll additions have been weak for quite some time as most companies have been running a tight ship considering the low capacity utilization currently. However, the surprising part is that production and new orders have dipped for the first time in the last 1 year and that is what is dragging the overall PMI-manufacturing down.

 

  • The slowdown seems to be a direct outcome of the liquidity shortfall created by demonetization. Most manufacturers were cutting back on fresh orders, adding fresh inventory and were even laying-off labour to compensate for the lower demand caused by the liquidity crisis. Average delivery times have lengthened indicating a weakening operating environment for Indian companies.

 

  • Services PMI for the month of December 2016 came in at 46.8, almost at par with the previous month. November had seen the first sharp fall in services PMI to the 46.7 levels. Normally, any liquidity crunch tends to hit the services sector immediately as they feel the impact with minimal lag. There is a lag by which the liquidity crunch begins to impact manufacturing. As a result of the impact of demonetization on Services PMI has been sharp and immediate.

 

  • The PMI clearly indicated that the weak performance of the Services PMI was a direct response to the sharp drop in overall business in the month of December. This was again largely due to the shortage of liquidity in the system. The actual liquidity shortfall in the economy will reach a level of stability only by end of February 2017 and till then the impact of the liquidity shortfall is likely to be felt on the PMI Services.

 

  • The slowdown in the services PMI has forced service providers to cut prices for the 3rd month in succession. Weak demand and tepid growth is forcing service providers to cut prices to sustain business at current levels. Services PMI become important because services account for over 60% of GDP and hence weak services PMI will translate into weak service sector growth. That is already apparent from the advance estimates of GDP announced on Friday.

 

  • The Composite PMI (combining manufacturing and services) for December 2016 has come in at 47.6, sharply lower than 49.1 in November. This clearly indicates that overall GDP growth is likely to come under pressure due to the Composite PMI staying under the 50 mark for 2 months in succession.

 

  • While the impact of demonetization is clearly visible, the question is how will these numbers shape up post the end of the demonetization process from January 01st 2017 onwards? While a V-shaped recovery looks doubtful; if the PMI can sustain above the 50-mark in the next few months, then it can be a major boost to overall economic optimism.

 

The PMI numbers have surely raised some concerns for economists and policy makers in India. The next 2 months could be critical. If a rapid recovery does not happen, the actual impact on GDP could be much steeper than what was originally envisaged.

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