India manufacturing PMI falters but inflation continues to be high

India’s seasonally adjusted HSBC manufacturing Purchasing Managers’ Index (PMI) for September came dangerously close to slipping into the negative territory. It was at 50.4, only a tad above the 50 mark that separates expansion from contraction. Indeed, some of the sub-indices have already slipped below 50. The employment sub-index, for example, was at 47.9 for September, well into a contraction; it has been contracting for two months now. The new export index sub-index, too, has been below 50 for the last three months. PMI is a month-on-month seasonally adjusted indicator and its trend may therefore differ substantially from year-on-year numbers.

The September numbers come hard on the heels of the sharp fall in the composite PMI (both services and manufacturing) in August. The services PMI for September is yet to be released, but data show that the Reserve Bank of India’s (RBI) tightening is finally beginning to bite. The new orders sub-index has also slowed, which suggests that the weakness in manufacturing is going to persist. The new orders/inventory ratio is deteriorating, indicating slower growth ahead. Meanwhile, India continues to be one of the few countries with a manufacturing PMI above 50.

Unfortunately, the slowdown is only there so far as growth is concerned. The input price sub-index was at a high 62.1 in September, well into expansionary territory. True, it’s the lowest rate of expansion in many months, but it’s still elevated and above the long-term average. Moreover, the output price sub-index was at 55.5 for September, at almost the same level as in August. The continuing increase in the output price index suggests that manufacturers still have pricing power and are in a position to pass on at least part of the hike in input prices. Incidentally, the HSBC China PMI, both for manufacturing and services, continue to show high levels of increase in output prices.

Will the September PMI result in RBI pausing? The central bank’s stance was most recently spelt out by governor D. Subbarao in a speech at the Stern School of Business at New York on 26 September. He said that at the current high levels, “inflation is unambiguously inimical to growth; it saps investor confidence and erodes medium-term growth prospects. The Reserve Bank’s monetary tightening is accordingly geared towards safeguarding medium-term growth, even if it means some sacrifice in near-term growth”. The rise in output prices indicates that demand pressures continue to be strong. HSBC chief economist for India and Asean (Association of Southeast Asian Nations) Leif Eskesen explains it thus: “It will still take some time for capacity tightness to ease significantly despite the expected slowdown, which will leave underlying inflation pressures firmly in place for a while still.”

Moreover, there’s another reason why RBI may be loath to change its stance—economists agree that the budgeted fiscal deficit target for FY12 is likely to be breached. And this is what Subbarao said in his speech in New York: “For monetary policy to be more supportive of growth, it will be necessary for fiscal consolidation to take root more firmly.”

All these signals suggest the central bank may not change its stance in a hurry, in spite of the manufacturing slowdown. Unless the situation in Europe becomes worse, which of course is eminently possible.