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Why has the manufacturing sector been witnessing a downturn, as measured by GDP and other data

The story so far

Over the last six months, the manufacturing sector has been witnessing a downturn and it has shown up in quarterly Gross Domestic Product data as well as the high frequency data from the sector.

What is happening?

Quarterly growth rate data released by the government at the end of February shows that growth in the manufacturing sector has slowed to 6.7% in the third quarter of this financial year from 6.9% in the previous quarter, which was itself much slower than the 12.4% registered in the first quarter. This compares unfavourably to the previous year as well, where growth had touched 8.6% in the third quarter.

Even the high frequency monthly data shows that growth in the manufacturing sector is slowing. The government-released Index of Industrial Production showed that growth in the sector slowed to 1.35% in January 2019, down from the already-anaemic 2.95% in December 2018. Growth in the sector was at 8.69% in January last year.

The private sector Purchasing Managers’ Index has shown the opposite trend, with activity in the manufacturing sector growing strongly in the last few months. This can be explained by the fact that, while the GDP and GVA (gross value added) data measures actual output from the industries under consideration, the PMI figure is arrived at following a survey of perception.

Why is this happening?

The current problem with the manufacturing sector is that it is overwhelmingly dependent on domestic demand. Exports have not been doing well due to subdued demand from global markets, but that is not something the government or Indian industry can control to any significant extent. Unfortunately, domestic demand—something the government can influence to a much greater extent—has also been subdued.

One of the main ways in which the government can boost demand is by increasing its own investments. Economists feel that while growth in gross fixed capital formation has remained pretty constant at about 13% over the last three quarters, it will slow significantly in the fourth quarter (January to March) as the government struggles to meet its fiscal deficit target.

The government has revised its fiscal deficit target to 3.4% of GDP in this financial year, up from 3.3%. But even this seems a tough ask given that direct tax collections—currently the strongest pillar of government receipts—will likely not achieve the expected target for the year. Economists say the government’s revised target for the year, which accounted for a 19% growth in direct tax collections, was too ambitious. The actual growth rate will likely be in the range of 14-15%. With indirect tax revenues falling below expectations consistently, lower direct tax collections will mean that the government will have to rein in its expenditure if it wants to meet its fiscal deficit target.

This has apparently been happening in January and February, which has resulted in a manufacturing slowdown. Prior to that, indirect tax experts say that uncertainty around the Goods and Services Tax and the rate changes the GST Council has implemented has resulted in consumers deferring their purchases and companies holding back on ramping up production until there is stability.

How will it impact the economy?

The economy and the manufacturing sector are intertwined to the degree that a slowdown in one almost naturally implies a slowdown in the other. The manufacturing sector makes up about 18-20% of the economy, and so a slowdown in the sector impacts the overall economy. On the flipside, a slowdown in the economy is associated with a slowdown in demand, and this impacts manufacturing. So, the fact that the government has pegged overall economic growth in the third quarter at 6.6%, the slowest in five quarters, does not bode well for the manufacturing sector.

That said, economists believe that the pain for the sector will be short-lived. The government’s constraints with regard to expenditure will last only for the duration of this financial year. As soon as the new financial year begins on April 1, the government will be free to ramp up its expenditure and boost demand. The trend usually has been for it to front-load its expenditure.

Further, bodies like the Engineering Exports Promotion Council have been saying that exports are starting to pick up despite subdued global demand, which is also expected to help the manufacturing sector grow faster.

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Printable version | Jan 20, 2020 6:50:48 AM | https://www.thehindu.com/business/in-slowdown-mode/article26555895.ece

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