Slowing Industrial Production : Reasons & Solutions

Industrial production declined at a 2.2 percent annualized pace through the first half of 2019. It’s tempting to interpret the slump as an early warning of a faltering economy, but a closer look at the headwinds facing the nation’s manufacturers reveals several idiosyncratic forces behind the slowdown. Tariffs are unlikely to have been a major factor in the decline, and the underlying support from consumer demand remains strong.

Industry’s slowdown has been concentrated in the energy, automotive and aerospace sectors due to unique forces that are likely to subside without causing broader economic disruption. Despite falling industrial production, the tightening labor market implies that the expansion still has momentum.

The Index of Industrial Production (IIP), considered as the representative of industrial growth in India witnessed the reduced growth of 2.7% in May 2015 making a dent on the tall claims of the government about the revival of high growth phase. The overall growth of the secondary sector for the month of April was also revised downward to 3.4% from the earlier estimated 4.1%.

The slowdown in the industrial growth was driven by the slow growth in manufacturing sector from 4.2% in April 2015 to 2.2% in May 2015. Among the sub-sectors of industry: mining and electricity sectors improved to 2.8% and 6% respectively but consumer good industry contracted by 1.6%.

The consumer durables and non-durables both saw the negative growth of -3.9% and -0.1% respectively. Capital goods also dragged the industrial growth as they saw a meagre 1.8% growth in May 2015 as compared to 6.8% in April 2015.

Despite the improvement in core sectors like electricity and mining, slower growth in capital goods indicate that business sentiments are still not strong enough to make companies add machinery to their production lines to increase the production.

Are Tariffs to Blame?

Escalating trade tensions are undoubtedly concerning for businesses that rely on international supply chains and sales to overseas markets. But the actual tariffs levied so far amount to a relatively small slice of the US economy.

Last year’s $35 billion worth of tariffs on Chinese imports amounted to only 0.18 percent of American GDP, and its impact was offset by devaluation of the Chinese renminbi, which discounted Chinese goods on the US market.

If trade tensions really were behind the industrial slump, high-tech manufacturers should have been the hardest hit. Yet this sector has been one of the brightest spots in US industrial production, expanding at a 9 percent annualized pace this year, almost triple last year’s growth rate. America’s high-tech manufacturers have had little trouble sourcing components from foreign suppliers and selling their products overseas.

The Bigger Picture

Industrial activity is still important to the economy, but as a share of GDP, manufacturing has shrunk considerably from past decades. Today, industrial production represents only 11.5 percent of the economy and accounts for about 8 percent of the workforce; it’s possible for manufacturers to make modest cutbacks without stalling overall GDP growth.

As the headwinds facing the nation’s energy, automotive and aerospace manufacturers subside, industrial production should return to alignment with consumer demand. As always, layoffs are providing a reliable indicator of whether a disappointing economic indicator is actually causing distress for businesses. So far, industry’s slump hasn’t created a surge in applications for unemployment benefits; this implies that manufacturers aren’t making permanent staff cuts, confident that their assembly lines should soon be operating at full capacity.

Reasons of Slowdown

The negative growth of consumer goods was a significant drag on the industrial growth in May 2015. The demand for consumer goods has contracted in May 2015 due to low demand from rural areas. The unseasonal rainfall during the harvesting season in April resulted in heavy loss of rabi crops in general and wheat in particular adversely affecting the income of the farmers. Loss of income resulted in reduced demand from rural areas and ultimately affecting the growth of consumer goods.

Slow growth in capital goods and manufacturing indicated that investment climate is still not positive enough to usher high growth and signals the need of urgent reforms. Though government has made some moves to reduce the hassles in doing business in India, country still ranks low in doing business. Slow growth indicates that there is still a lot of scope to improve the investment climate. Reduced demand, infrastructural bottlenecks and many archaic laws are putting impediments for the high growth. When it is easy to do business in low cost countries like Bangladesh, Vietnam why would an international manufacturer invest in India. The cyclical upswing in demand can definitely improve the growth but this would not be sustainable.

Possible Solutions

As far as consumer demand from the rural sector is considered, it is likely to improve due to better than expected monsoon and we can see better growth of consumer sector during the third quarter. Reserve Bank on its part may reduce the interest rates to improve the investment climate as inflation is likely to remain within safe limits. But major thrust had to come from the government. However, ad hoc measures would only give a temporary boost to the growth.

For permanent solution, government must ensure positive and enabling environment. For that matter comprehensive reforms are required in every sector including labour relations, policy solutions, infrastructure improvements, energy reforms, financial reforms, skill enhancements etc. Along with aforesaid measures, bureaucratic hassles must be reduced to minimum because in comparison to other nations, red tapism plays a significant role in delaying the assured investments while denying the possible investments.

Moreover, government cannot bank on any one measure to usher growth but a holistic approach is required for a diverse growth that can gainfully absorb the increasing Indian work force.