LSM forecast underestimated?

The large scale manufacturing (LSM) index has posted a growth of 5.58 percent in the ten months ending April 2017. That’s significantly up from year-on-year growth of 3.95 percent in the same period last year.

The reasons for improved growth can be explained by several factors. For instance, the growth in sugar production can be explained by much higher sugarcane production thanks to higher area under cultivation. Farmers had replaced cotton and to some extent rice, with sugar cane compared to the year-ago period, which is why the production of cotton yarn and cloth has been rather flat this year.

Meanwhile, cement production is booming on account of infrastructure spending by the public sector and the construction boom in the private sector. Channel checks suggest cement industry is already operating at a capacity of about 90 percent (up from 80-85% last year). In the ensuing year, new capacity expansions may commence early next year though delays in expansion are oft the norm and are expected. No new capacity is expected to come online before the last quarter of fiscal year 2018, which means the upside in LSM’s cement component is rather limited.

The auto story is somewhat similar. So far the year has seen a boom in auto production and sales due to a rise in government employment schemes and rising consumer demand, partly facilitated by cheaper interest rates that have lead to a growth in auto loans. Some of the hot locally produced models are being purchased at fresh-off-the-factory premiums due to limited production capacity. There is little scope for a major turnover in production over the next fiscal year since most new car ventures likely to commence production toward the end of FY18.

As for FY17, if historical cyclical trends are any guide, the full year growth number may well be north of 5.5 percent, as against forecast estimate of 4.93 percent presented by the Finance Ministry in its Economic Survey 2017.

The cyclical nature of items tracked by the LSM index is such that the last quarter of each fiscal year always sees the index go south. Keeping that factor in mind, the LSM would have to drop by 8.25 and 7.85 percent month-on-month in May and June respectively to meet the FinMin annual LSM growth forecast of 4.93 percent. Those drops do not look too steep to be real given historical trends; nor is there any reason for the same apparent at the moment.