PMI : A leading or misleading indicator? (The Hindu)

Mains Paper 3:Economy 
Prelims level: Purchase Managers’ Index
Mains level: Reliability by using the Purchase Managers’ Index data 

Context:

• The Purchase Managers’ Index (PMI) is a widely used economic indicator that gives an insight into business conditions. 
• It is a survey-based diffusion measure provided by Markit, by compiling responses of purchasing managers (executives) of 400 companies every month. 
• The aggregate final measure is a seasonally adjusted number on the scale of 0-100, where values above 50 reflect an increased expectation of overall business conditions compared to the previous month, whereas values below 50 indicate a decline. 

What is a PMI?

• PMI or a Purchasing Managers’ Index (PMI) is an indicator of business activity -- both in the manufacturing and services sectors. 
• It is a survey-based measures that asks the respondents about changes in their perception of some key business variables from the month before. 
• It is calculated separately for the manufacturing and services sectors and then a composite index is constructed. 

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Uses of Purchase Managers’ Index:

• The PMI is computed for manufacturing as well as for the services sector. 
• The values are a weighted average of responses related to questions on new orders (30 per cent), output (25 per cent), employment (20 per cent), suppliers’ delivery (15 per cent), and stock of purchases (10 per cent).
• The PMI is regarded as a proxy for business conditions as well as a leading indicator of the Index of Industrial Production (IIP). 
• While the IIP numbers are revised, a consensus among economists is that the IIP and PMI plausibly capture a similar trend. 
• This gives us a reason to empirically examine if there is a sustained correlation between the IIP and PMI of the manufacturing sector. 

Mapping the correlation:

• Since the PMI is considered a leading indicator, we carry out two sets of analyses. 
• First, we examine the simple trend by juxtaposing annual growth of the IIP index (manufacturing) and the previous month’s PMI (same results hold with contemporaneous trend analysis). 
• Second, we examine their correlations during the period March 2014 to February 2020 (latest) over rolling windows.

Reliance on PMI:

• Empirical evidence indeed suggests that the PMI is not a consistent leading indicator for industrial production.
• Reliance on such indicator for macro policy-making is fraught with serious risks. 
• One can get an impression about how the PMI information is used in policy-making from the discourse of the Monetary Policy Committee (MPC) of RBI. 
• In this regard, to carry out a simple text analysis and measure the number of instances where “PMI” appears in the minutes of the meeting of MPC. 

Lack of clarity?

• To speculate on why the PMI can be a poor indicator of economic activity in India. 
• As per the official website, the PMI is constructed using the actual changes in the volume of business output. Hence, the quality of assessment of the respondents, and of the ground reality, will drive the observed pattern of changing correlation between the PMI and IIP. 
• Another possible reason could be that 400 may not be a large enough representative sample to capture the diverse production scenarios of all the firms operating in the manufacturing sector in India. 
• Also, it is not clear exactly how many executives respond every month, and if there is a panel. 
• Research on the effectiveness of the PMI tracking manufacturing activity in India within and outside the central bank has been quite inadequate. 

Conclusion:

• Therefore, as long as it gets wide publicity in the press and policy discourse, the PMI will continue to influence suboptimal policy outcomes. 
• But one wonders if the PMI actually leads or misleads economic activity in India.

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Prelims Questions:

Q.1)With reference to the All India Agri Transport Call Centre, consider the following statements:
1. The 24x7 service All India Agri Transport Call Centre is an initiative of the Department of Agriculture, Cooperation and Farmers Welfare.
2. It is operated by the IFFCO Kisan Sanchar Limited (IKSL) from their offices in Faridabad, Haryana.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer.....................

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Mains Questions:
Q.1) What is the Purchase Managers’ Index? What are the uses of it? How reliable is the PMI index as a proxy for business conditions of the manufacturing sector in India?