Explained | Q2 GDP: Does manufacturing data flatter to deceive?

“Despite being the worst affected sector in Q1, it is quite puzzling how manufacturing turned itself around. The IIP manufacturing and Manufacturing GVA growth are highly correlated (almost more than 0.90) and this correlation collapsed in Q2 when IIP manufacturing declined by 6.7 per cent while manufacturing GVA grew by 0.6 per cent,” says Soumya Kanti Ghosh, Chief Economic Advisor, State Bank of India

Another indicator, which while it is not used as in input to calculate GDP, is a reliable barometer for sentiments in the manufacturing sector is the Purchasing Managers Index (PMI-Manufacturing). It tends to precede changes in the trend in major estimates of economic activity and output.

PMI contracted in July faster than June, rose in August for the first time since the lockdown, but then shot up to its highest level in September, since 2012.

That still does not explain the strong showing by the manufacturing sector in Q2. Production had still not come online fully, capacity was still not being fully utilised and all the manufacturing jobs lost in the lockdown had still not come back 100 per cent.

Perhaps that is only what explains the positive manufacturing numbers. The pandemic gave companies a chance to slash costs and build up an inventory of products which could not be sold during the lockdown.

Ghosh said that one possible reason for encouraging manufacturing GVA data could be a “massive purge in costs. Further, we observed small companies, with a turnover of up to Rs 500 crore, are more aggressive in cutting cost, displaying a reduction in employee cost by 10-12 per cent. This could turn a potential headwind in future in terms of a drag on consumption. Additionally, there is evidence of inventory build-up that could act as a drag on future manufacturing growth.”

However, analysts also warned that in subsequent GDP revisions, manufacturing numbers could be altered as well.

“While manufacturing volumes had continued to contract, the GVA of this sector posted a marginal growth on the back of aggressive cost-cutting measures, a pared-down wage bill and benign raw material costs. Nevertheless, the extent of the recovery in the performance of the informal sectors in Q2 FY2021 remains unclear, and we caution that trends in the same may not get fully reflected in the GDP data, given the lack of adequate proxies to evaluate the less formal sectors,” said Aditi Nayar, Principal Economist at ICRA.

This does seem clear. Manufacturing GVA went into positive territory in July-September more because of factors like cost cuts and inventory build-up than because of a substantial increase in the activity.