Where Purchasing Managers lead

One of the most widely tracked macroeconomic indicators used in over thirty countries is the PMI (Purchasing Managers’ Index).

The PMI is released every month — first a flash index followed by a full fledged one — by Markit , a global financial information services company. It is a lead indicator which gives a peek into where an economy is headed.

It tracks the manufacturing and the services sectors. Besides Markit, the Institute for Supply Management also comes out with PMIs but only for the US economy.

The Manufacturing PMI is a leading indicator. That is, it gives an insight into what is likely to happen based on whether new orders are being placed, more workers are being hired and whether the delivery time is reducing. The Index of Industrial Production (IIP) on the other hand, is a lagging indicator that measures past performance (production).

Nonetheless, both the indicators are required. For knowing how the manufacturing sector is likely to do in the coming months is as important as knowing how the sector has actually performed.

To start with, responses from senior executives in manufacturing and services companies are sought on whether the business conditions for a number of variables — new orders, output and employment, to name a few — have improved, deteriorated or stayed the same vis-a-vis the previous month.

This data is then used for constructing the New Orders Index, Output Index, Employment Index, Suppliers’ Delivery Times Index and Stock of Items Purchased Index. Each of these indices is calculated as a weighted sum of P1, P2 and P3. That is, the index equals (P1*1) + (P2*0.5) + (P3*0) where P1, P2 and P3 refer to the respective percentage of answers that reported an improvement, no change, and a deterioration in business conditions.

The Manufacturing PMI is then arrived at by taking a weighted average of these five individual indices. The Services PMI too is calculated as a weighted index of some individual indices relevant to the sector.

Interpretation

Next is interpretation of the indices. Take for instance, the New Orders Index (NOI). If all executives report an improvement, that is P1 is 100 then the NOI equals 100. On the other extreme, if all report a deterioration, then P3 is 100 and so the NOI equals 0. If all report no change in conditions then P2 equals 100 and the NOI reads 50. Thus, a reading above 50 indicates an improvement while anything below 50 suggests a decline. The same is true for the other individual indices. Since the PMI is simply a weighted average of these individual indices, the same interpretation extends to the PMI.

The recently released July Flash Manufacturing PMI for China points to a deterioration (PMI value below 50) for the third month in a row. The index is down from 48.2 in June to 47.7 in July. This is not surprising given the recent spate of disappointing data from China.

In contrast, the India Manufacturing PMI at 50.3 for June points to a marginally expanding manufacturing sector, up from 50.1 in May. At the disaggregated level output declined a tad in June as a result of weak demand and power cuts. New orders too fell. As regards employment, there was some job creation during the month. Suppliers’ delivery times were lengthened on account of power and raw material shortages. Stocks of goods purchased rose only modestly with most manufacturers reporting no change in stocks from the previous month.

The India Service PMI for June showed that the services sector expanded (above 50) though at a modest rate. In fact, the index fell from 53.6 in May to 51.7 in June.

A major advantage of the PMIs is that they are released at the start of every month much before the release of other data. Also, with the methodology used being the same across countries, international comparisons are possible. But, the PMI surveys cover only the private sector.

>maulik.tewari@thehindu.co.in

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