Disclaimer: The IIP may not be what you think it is.

I wish I had written the following article a month ago. I, for some time, have been a believer that we are going to see an inflection in the business cycle of India. But every time I would utter such a view point I would be met with an onslaught of sell-side and media reports talking of how corporate India is bleeding. The key metric that traders await to affirm this negative view is the monthly Index of Industrial Production (IIP). Until Friday June 12^th, the numbers for this year have been disappointing and non-indicative of any real activity growth in the economy. (I am a non- believer of the index but do not intend to change your stand on it).

For a number that is quoted very often in leading financial newspapers and used frequently by traders to move markets in either direction, very little reporting is done on the method of arriving the number. Below is the disclaimer that any report judging the economy’s strength on the IIP, should contain.

“The all India IIP is a composite indicator that measures the short-term changes in the volume of production of a basket of industrial products during a given period with respect to that in a chosen base period.” So in other words, the IIP is an abstract number which represents the magnitude of the production in the industrial sector for a given reference period. The IIP index published in India by the Central Statistics Office (CSO), however, only deals with registered manufacturing units. By definition this includes those manufacturing units that employ 10 or more workers and use power; and 20 or more workers but use no power. On an average, the entire manufacturing sectors accounts for 16% of India’s GDP. 10 percentage points of that comes from registered manufacturing units but 6 percentage points of that comes from the non-registered manufacturing units, which get ignored in the IIP calculation. Therefore, the indicator the market uses to gauge the manufacturing strength in India in fact ignores 37.5% of the manufacturing in the country.

Also, the United Nations Statistics Division expanded the scope of the index to include Mining & Quarrying, Manufacturing, Electricity, Gas steam and Air-conditioning supply, Water supply, Sewerage, Waste management and Remediation activities. Due to constraints of the data availability and other resources, the present general index of industrial production compiled in India has in its scope limited to Mining, Manufacturing and Electricity sectors only. Thus of the 10 percentage points, a few registered manufacturing units are still not covered in the Index given the limited scope of the survey.

It is difficult for the CSO to standardize the data even within this limited scope. With 16 different sources contributing to the index, standardization of data collection across the nation becomes an even more of an impossible task.

This difference in data collection could result in the index portraying a different picture of the ‘ground reality’ than the true facts. For example the sample size for data collection for the different components is decided by the respective source agency. The only guideline stated in the CSO handbook says, “Generally, efforts are made to cover all the major units”. The definition of major is however left up to the source agency and it has changed with time depending on whether the department is understaffed or overstaffed.

“The basic data used for compilation of the index is the production in terms of quantity. However, there are certain items especially capital goods such as Machinery, Machine Tools, Ship Building etc. on which the production data is furnished in value terms. In order to remove the effect of price rise from the index, the production figures of such items are deflated on the basis of Wholesale Price Indices (Base 2004-05), compiled by the Office of Economic Adviser, Ministry of Commerce and Industry, before compilation of index.”  This is yet another example of how the different sources of data can lead to discrepancies owing to differing methods of data collection.

Given the size of the undertaking, and the varying sectors covered by the index, it would be nearly impossible to conduct the operation without different sources. It is however the lack of standardization across departments and the consequent lack of data validation checks that require this to be highlighted as a glaring drawback in the quality of the data point released every month.

Before releasing the data, the CSO confirms the accuracy of the data points with the source agencies if there is a significant deviation from the data point in the previous month.  The underlined word in the previous sentence demonstrates the peril of using such an index.

The intention of this article is not to convince people to ignore the IIP numbers altogether but rather to provide a disclaimer for those ‘consuming’ this index. Put in a cliché manner, the intention is to provide one with the grain of salt to ‘consume’ this data with.