Do it yourself

Recently the Ministry of Statistics and Program Implementation, Government of India, released the results of the latest Annual Survey of Industries (ASI) for the reference period FY23. The Annual Survey of Industries is conducted with the primary objective to provide a meaningful insight into the dynamics of change in the composition, growth and structure of various manufacturing industries in terms of output, value added, employment, capital formation and a host of other parameters.

I note the following key points from the survey results.

Key statistics (five-year period from FY19 to FY23)

·         Number of total factories in the country has grown at a CAGR of 1.2%, despite the government’s strong emphasis on manufacturing and multiple incentives.

·         Total fixed capital (investment) employed in manufacturing has recorded a growth of 4.4% CAGR. Total invested capital has grown at a CAGR of 6.5% during this period, implying higher working capital requirement.

·         Total employment in the manufacturing sector has grown at a CAGR of 3.2%. This is sharply lower than the rise in the labor force.

·         Total factory output has risen at a CAGR of 11.8%, while output per worker recorded a growth of 4.8% CAGR.

·         Average industrial wage has grown at a CAGR of 5.1% against the average CPI inflation of 6.6%, implying sharp deceleration in the real wages.

·         The ratio of contract workers to the total workers has increased from 38% (FY19) to 41% (FY23).

·         Manufacturing productivity has shown some improvement, but this may be far below the desired levels. Fixed capital to output ratio has improved from 37% to 28%. GVA to fixed capital ratio improved from 44% to 53%. Wage cost to NVA improved from 36% to 34%.

Stark regional imbalances

Five states account for more than 52% of factories in the country. The nature of activities, productivity and employment level of the industry in these states also appear to be different.

·         Tamil Nadu accounts for 15.7% factories, deploying 7.9% of the total fixed capital, employs 15% of the total industrial workers and produces only 10.3% of GVA - implying more proportion of labor-intensive small industries.

·         Gujarat accounts for 12.2% factories, deploying 19.7% of the total fixed capital, employs 12% of the total industrial workers and produces 14.8% of GVA - implying dominance of heavy capital-intensive industries.

·         Amongst the top five industrial states, Uttar Pradesh is the least productive. The most populous state in the country accounts for only 7.5% of total factories, employs 8% of the total industrial worker and contributes just 6% of GVA.

Food business getting more organized

Factories producing food products, 16% of the total number of factories, are now the largest category of industrial units in the country. These factories employ 21,16,000 or 11.4% of the total industrial workers, more than any other industry. The traditional largest employer, textile industry, comes a distant second employing 17,23,000 workers.

Food products industry now contributes 7.1% of the manufacturing GVA, 73% more than the 4.1% contribution of the textile industry.

…but basic metal continues to dominate

Basic metals’ industry employs 17.6% of the total fixed capital, and contributes 11.6% of the GVA. The employment intensity of the Basic metal industry is low as it employs only 7.6% of the industrial workers.

 The latest episode of global inflation is impacting peoples’ lives in multiple ways, especially in developed countries where the present generation of citizens has not experienced this kind of rise in the cost of living; borrowing cost and challenges in accessing consumer credit. It is of course a significant challenge for the young investors and professional money managers who have been raised in an environment of profligate fiscal policies; abundance of liquidity; near zero cost of borrowing; persistent struggle to mitigate the deflationary pressures and unchallenged US supremacy over global markets and geopolitics. For them all the assumptions that underlined their investment strategies might be falling apart; just like the Dreamliner Titanic.

This episode of inflation and consequent monetary tightening would indubitably prove to be an important life lesson for the young investors and money managers; and go a long way in defining the future investment strategies and market directions.

Besides, there are some other noticeable side effects of the inflationary pressures on the global socio-economic milieu. For example consider the following:

There are several reports indicating that harassed by the rising cost of living and high rentals, many youngsters may be returning to live with their parents; several more may have delayed the decision to leave the parental homes; yet some other who were living alone are moving in with their partners and friends to save on rental and other costs (for example see here). It may be too early to conclude anything, but if this trend sustains we might find it catalyzing some interesting changes in the demographic profiles of many countries; housing market; immigration policies etc.

There is enough anecdotal evidence available to indicate that employees demand higher wages to manage the rising cost of living; but they seldom agree to wage cuts during the deflationary phase. The businesses therefore usually engage in workforce realignment to optimize their wage bill. The senior employees whose actual contribution is stagnating but wages are rising, are invariably replaced by younger employees which cost much less simply due to their lesser vintage. Inflation thus causes higher unemployment in middle and upper tier employees, who are either forced out of the labor market or accept new jobs at much lower wages. The governments however do not have this luxury of letting senior people go. They usually meet the goal by imposing a moratorium on fresh hiring and rationalizing non-wage costs, e.g., travel.

The products’ prices usually do not move in direct proportion to the raw material prices. During raw material inflation the margins of most companies shrink, unless they enjoy significant demand elasticity for their respective products and are able to pass on the entire raw material inflation on to their customers. However, during the raw material price deflation phase, a majority of companies do not pass on the benefit to their customers. This is the phase when most companies, that have survived the inflationary period, see their margins expanding.

As the rate of inflation declines, the prices of consumer goods do not necessarily fall. They just stop rising at a faster rate. Thus, if the wages of households have not risen in line with the rise in the cost of living, the hit to their consumption and/or savings could become structural.

Financial repression is one of the worst impacts of inflation. The savers lose real income while the borrowers get money at much lower real cost. Post inflation this situation is rarely reversed. Neutral real rate is usually the best case in a deflationary period. Positive real rates are not seen to last for any meaningful period.

To control inflation, a variety of fiscal and monetary policies are used by the governments and central banks. Higher interest rates, lower liquidity, higher tariffs to curb demand, subsidies to the poor to augment their income are some of the popular tools used to mitigate inflation and its impact. However, in case of deflation the use of fiscal policies is not very popular; even though in some cases incentives are offered to encourage demand. Withdrawing fiscal subsidies and incentives in the post inflation period however proves to be a serious political challenge. Thus, while the monetary expansion could be moderated in a relatively shorter span of time, the fiscal corrections could take much longer.