PMI and GDP

PMI or Purchasing Managers’ Index and GDP of a country are known to move together. Let us examine what PMI actually tells us and if the hypothesis of PMI and GDP moving together holds true.

When we talk of the performance of the manufacturing sector of the country, Purchasing Managers’ Index or PMI is one of the most widely used indices. PMI is an economic indicator that surveys purchasing managers at businesses that make up a given sector. It is a composite index with five sub-indices, viz., production level, new orders, supplier deliveries, inventories and employment levels. On the questionnaire, the managers mark these indicators relative to the previous period. PMI is a very important sentiment reading measure not only for manufacturing, but also for the economy as a whole.

50 is the magic number- a reading of 50 or higher represents that the manufacturing sector is expanding. If the manufacturing sector is expanding, the general economy should also be doing likewise because when manufacturing sector grows, backward and forward linkages come into play. Agro based industries grow and allied services also develop. Thus, it is considered a good indicator of future GDP levels.

But there are certain qualifications that we should keep in mind here. PMI of 50 or higher may not necessarily mean that the economy is doing relatively well. As the name suggests, PMI measures only the performance of the manufacturing sector. If manufacturing is not the dominant sector of the economy, a consistent rise in PMI might not translate into GDP growth over the previous period. There is always a possibility of growth in manufacturing not leading to growth in non-manufacturing sectors. This happens when the backward and forward linkages are absent.

In the case of India, the contribution of services to the economy is more than that of manufacturing activity. Now had these services developed because of manufacturing, PMI would have been a good indicator of GDP growth rate. However, the services sector in India developed faster than the manufacturing sector. India moved from being an agrarian economy to a services driven economy, with manufacturing never getting the bigger share of the pie. Thus, this development had little backward linkages. For reading India’s PMI we need to consider this scenario. Only when service sector develops through manufacturing, can we conclusively say that PMI will translate into GDP growth over period and reflect true sentiment in the economy.

Let’s have a look at the data. Till July 2013, India’s PMI was above 50. Our GDP is growing albeit at a slower pace. Here is an example where a PMI of above 50 doesn’t reflect the true sentiment in the economy. For emerging economies of India a low growth rate over the previous period is looked down upon.

Such a mismatch can also arise when the economy is recovering from a slowdown. When the economy is rebounding from a recession, new orders come in, production has to be increased. Till the time production is increased- inventories go down- which was high during the recession. Out of the five components of PMI, four would go up. But one factor going down can have a depressing effect on the overall index. Thus, even though the GDP growth rate might be more than the previous period, it immediately might not translate into a higher PMI.

India’s PMI for the first time since 2009 has fallen below the benchmark level of 50. A PMI of 48.5 represents that manufacturing sector is not expanding. This data is for August 2013. However, with Index of Industrial Production recording an increase, the number for PMI too is expected to improve next month.

PMI is the timeliest data available (every month) to get an idea of the health of the economy. However, while interpreting the number, these qualifications must be taken into account.

Contributed by:

Prerna Banga

Section A, Economics

Batch 2013-15

De-Jargonize

MULTIPLIER: A multiplier summarizes the total impact that can be expected from change in a given economic activity.

K =ΔY/ΔI

It is an initial change in aggregate demand that can have a much greater final impact on national income. This is known as the Multiplier effect.

The working of multiplier tells us as to what will be the final change in income as a result of change in investment. Change in investment causes a change in income. And as a result of change in income there is change in consumption which in turns leads to a multiply of change in income. Here I- Investment, Y- Income, C- Consumption.

ΔI →ΔY→ΔC→ΔY….

 

It comes because of injections of new demand for goods and services into the circular flow of income stimulate further rounds of spending as one person’s spending is other person’s income. This in turn leads to a bigger effect on output and employment.

1.      Injections: Injections are non-consumption expenditureon aggregate production. The three injections are investment government purchases and exports. These are termed as injections because they are "injected" into the circular flow of consumption, production, and income.

2.      Leakages: A leakage is the diversion of income from the flow of domestic spending. The three leakages are saving, taxes, and imports. These are termed as leakages because they are "leaked" out of the circular flow of consumption, production, and income.

3.      Balanced budget multiplier: It is the measure of the change in aggregate production caused by equal changes in government purchases and taxes. This multiplier is the combination of expenditure multiplier and tax multiplier.

Expenditure multiplier measures the change in aggregate production caused by changes in an autonomous expenditure.

The tax expenditure measures the change in aggregate production caused by changes in taxes.

4.      Planned Expenditure: This is the total amount the economy plans to spend in a given period. It is announced beforehand about the amount of activity which is going to happen. Example: Defense which is largely financed through loans.

5.      Non Plan Expenditure: All the expenditure incurred in connection with maintaining normal services is called non-plan expenditure. It is the residual after the planned expenditure.

Contributed by:

Tanvi Lal
Section A, Economics

Batch 2013-15

 

A look at Consumption Hypotheses

In this unpredictable situation, the future of the Indian Economy looks bleak. How much to spend? How much to save?

Answering these questions would be difficult for all the three sectors-household, Government and the Private Sector. Starting September, consumption will increase because it is considered auspicious to buy new products such as cars and televisions for the main Hindu festival, Diwali, to be celebrated in November.    

The consumption hypotheses proposed by certain eminent economists would be useful in forecasting the future consumption during these situations. The need for essentials like fuel, petrol, LPG cannot be compromised and the prices of these commodities are skyrocketing. But there is a shortage in consumption of this particular product. Accordingly, there is a shortage in consumption with an expectation that price of the product will come normal in future but the hike in the price of petroleum is permanent for a long term [which follows the Permanent Income Hypothesis-Milton Friedman.]

Other industries like the airline, bullion market and basic items like plastic industry are also facing the heat. Prices have been fluctuating in the recent times and there is no stability as of now. The need for instant gratification, hypothesis proposed by David Liabson, has always been a significant part of human psychology which should be curbed to increase savings and in turn help in future investments.

So it remains to be seen whether we need to bother about future consumption now or focus on the current consumption issues.

Contributed by:

Gayatri K

Ayushi Agarwal

Pooja Agarwal

Section A, Economics

Batch of 2013-15

Top 5 News Feed

PETROL PRICE MAY COME DOWN UP TO Rs. 1-1.50 per litre-

Petrol price may be cut by as much as Rs. 1-1.50/litre next week on falling international oil rates and appreciating rupee but a onetime hike in diesel and LPG rates is still on cards.

 In my opinion, fall in petrol prices caused by the reduction in international oil rates would help in appreciation of rupee as the prices would stabilize or decrease once the Syrian war cools down. However, the possibility of rising LPG and diesel rates would be a burden borne by consuming population as it’s an economic and political challenge. Moreover, the subsidy burden has reached unsustainable levels which cannot be financed by government budget and oil cos. With limited financial resources, the government cannot run the risk of inflating the fiscal deficit as it would lead to further depreciation in rupee and downgrade in credit rating. Should the government consider all the above factors or go ahead with the price cut??

WON’T CROSS RED LINE ON FISCAL DEFICIT: P. CHIDAMBRAM

P. Chidambram has reiterated that the fiscal deficit budgeted for the year will not be crossed even when the economy is going through a period of stress. The gross direct tax collections rose 14.4% in April-August to Rs. 1.88 lakh crore as against Rs. 1.64 lakh crore lay year and according to CSO, a growth of 5% in 2012-13 has been reported for almost all states.

I am of the opinion that the government despite going through tough times is taking steps to address the situation in order to restore confidence in Indian economy. Looking at the 5% growth rates provided by CSO, government can find out where the growth is able to sustain and where it is not so as to take corrective action. However, this poses a question whether these measures are enough to control governmental expenditure and in affect stabilize rupee?

A HOUSING SLUMP IN INDIA: REAL ESTATE MARKET CRUMBLES AS ECONOMY SLOWS

The real estate market in cities across India is crumbling because of economic slowdown. The RBI has raised the short term interest rate for commercial bank borrowing to 10.25% in order to reduce leaving of money from the country which is followed by a regulation banning Indians from transferring money overseas for real estate purpose. India’s real estate developments may take a long time to build because of vast and corrupt regulatory practices. Moreover, publically traded real estate investment groups in India are heavily in debt.

In my view the volume of real estate transactions have slumped because of depreciating rupee which is scaring away foreign investors. Developers have refused to offer discounts for fear of starting market rout. The problem has been aggravated as sellers refuse to cut prices causing potential buyers to lose interest. One major complaint regarding Indian business practices is that banks lend to elite persons who often put little of their own money in such deals and rely on minority lenders and bank loans. Since repayments on loans are happening at a slower pace, these investors tend to lose heavily.   One example could be DLF; a pioneer in real estate which started OMR road in Chennai in 2007/08, but till date has not been able to sell even 50% of 3000 units. How does the government plan to deal with these issues?       

DELHI-MUMBAI INDUSTRIAL CORRIDOR: RS 1.2L-CR PROJECTS CLEARED

The government has cleared a raft of projects worth Rs 1.2 lakh crore under the much-hyped Delhi-Mumbai Industrial Corridor (DMIC) project as part of its initiative to spur manufacturing in the country. India's ambitious $90-billion DMIC project is aimed at creating mega industries infrastructure along the Delhi-Mumbai Rail Freight Corridor, which is under implementation. Japan is giving financial and technical aid, and has committed to invest $4.5 billion in this project. This will help in expansion of foreign direct investment and create both direct and indirect jobs in the economy.

In my view clearances of such projects will positively impact the economy only when they are implemented successfully. In the last 5 years, a large number of projects on the development side have not yet started due to land acquisition and environmental clearance problems.   Most of the NPA's in public sector banks are due to clearances such as these. The most crucial question remains unanswered as to whether this move is in lieu of elections or the government actually understands the need of the hour?     

WALMART’S INDIA PLAN BY SEPTEMBER-END

Wal-Mart has put its India expansion plans on hold as it deals with compliance investigations and unease over the government’s rules for foreign investment in retail businesses. They will now call by the month end as to whether it continues to do business in India or exit the Country all together. According to retail analysts, Wal-Mart and its subsidiaries have stopped expanding and Wal-Mart is also investigating whether company executives in India violated the US Foreign Corrupt Practices Act by lobbying.

In my view, If Wal-Mart and Tesco decide to withdraw from the India market for their own reasons, and then it’ll pose a big question on the government’s decision to open up retail. The UPA government was as it is under attack from foreign lobbies and was accused of "policy paralysis" last year. To appease them instant decisions were taken up to open sectors namely, retail, aviation & energy exchange.  But such a situation reveals lack of ground work for operations on India’s part. The country immediately needs to revive foreign investor confidence, but how does it plan to do so remains an unanswered question.

Contributed by:

Akritti Nirula
Section A, Economics
Batch of 2013-15

 

De-Jargonize

HFCE: Household final consumption expenditure: It generally includes expenditure incurred by resident households on individual consumption goods & services including those sold at prices that are not economically significant.

According to the domestic concept, it includes household expenditure made on the domestic territory by residents & inbound tourists.

GFCE: Government final consumption expenditure: Income expenditure which represents government expenditure of goods & services used for the direct satisfaction of individual needs by households. In India, government expenditure forms the largest part in the total expenditure; mainly because of defense.

ICOR: Incremental Capital Output Ratio: Minimum amount of capital required by a firm to make the next production unit. The lesser the ICOR, more efficient is the organization. ICOR is calculated as

ICOR = Annual Investment/Annual Increase in GDP

WHITE GOODS: Goods bought for the purpose of final consumption & not for resale. They are usually purchased by households. For e.g. refrigerator, ovens, air-conditioners, etc.

MARGINAL EFFICIENCY OF CAPITAL: It is the annual percentage return on last additional unit of capital .It is the rate of interest at which the investments become viable. If the marginal efficiency of capital was lower than the interest rate, the firm would be better off not investing, but saving the money.

Contributed by:

Bhupender Singh

Vimal Rajput

Section A, Economics

Batch of 2013-15