Thursday, August 18, 2011

What is IIP & why is it so important ?

IIP (Index of Industrial Production) denotes the total production activity that happens in the country during a particular period as compared to a reference period. It helps us to understand the general level of industrial activity in the economy. The products included for calculation of IIP can be segregated into 3 major sectors – Manufacturing (79.36%), Mining & Quarrying (10.47%) and Electricity (10.17%). Another way of categorizing the items used in the calculation of IIP is a ‘Use based classification’ with categories like Basic Goods, Capital goods, Intermediate goods, Consumer durables and Non-consumer durables.

The chart given above shows the movement of Sensex and IIP over the last 4 years. It is quite evident that the IIP and Sensex movement is closely related. The IIP data is not as volatile as the Sensex but even a 2-3% change in IIP can lead to a lot of swing in stock market movement. There are many other factors that impact the stock market, but IIP gives a very good indication of where it is headed. Consider for example the period from January 2010 to April 2010. The rise in IIP during this period has been reflected in the upward movement which saw Sensex touching 20,000 in September.

Thus, IIP can drive the stock market up or down. But how does IIP actually affect the stock markets and subsequently the economy?

Why/How is IIP the lifeline of Economy & Stock Market?

The relationship between the IIP and the stock market is backed by a whole chain of events.

The consumer spending is indicative of the demand in the economy. IIP, on the other hand, indicates the total production in the economy and is the other side of the coin i.e. the Supply side.

The diagram given above shows how lower IIP – which usually results due to lower consumer spending – can lead to a drop in stock prices.

Depleted consumer sentiment leads to a fall in consumer spending consequently leading to lower demand in the economy. If we are not buying more then why would companies produce more!! This leads to lower growth or sometimes even a de-growth in IIP. Thus, usually the immediate impact of poor IIP figures is falling stock prices.

Over the long term, continuous lower consumption leads to lower producer confidence. Negative sentiment about future demand further leads to reduction in investment activity & hence slows down the capital spending. This has an adverse impact on future sales & profits of the companies. Thus, the negative sentiment leads to an adverse investment atmosphere for both institutional and retail investors.

Lower supply coupled with lower demand can have catastrophic impact on stock market and was one of the main reasons for drop in Sensex from 20000 to 8000 in 2008. Thus, lower IIP is bad news for the Stock Market as well as for the growth of the economy.

So, how can you use IIP data to profit in the Stock Market?

In India IIP is released with a lag of 2 months. For instance the October 2010 IIP data is made available only in December 2010. Yet, the IIP data can give us much crucial information which can help us in our stock investments. Here are a few pointers to best utilize the knowledge of the IIP to profit in the Stock market.

  • Check the industry wise growth. A sustained fall in growth in a specific industry could be a good time to exit that industry and allocate your funds in stocks of a better performing industry.
  • If good IIP data is backed by buoyant consumer demand then announcements like capacity expansion, building of new factories etc. by companies you are tracking indicate a good future flow of income and hence an upside to their stock prices.
  • A continuous fall in overall IIP data may lead to many fundamentally strong stocks being undervalued. This gives you the perfect opportunity to invest in fundamentally strong companies at discount price.
  • If growth in IIP is backed by higher investment activity and also lending by the banks, then banking sector is likely to experience good growth. However, lower IIP growth could impact the banking sector adversely.

Thus, IIP gives you the overall picture of production activity in India and has the might of altering the course of stock market movement.


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