Here's the front page news for basically every mainstream media today (6th September 2022):
a. India's service sector Purchasing Manager's Index (PMI) has climbed up to 57.2 in August 2022, from 55.5 in July.
b. Media reports that anything above 50 indicates expansion.
Considering the given pieces of information, you may at best conclude that India's service sector is doing well. But did you ever wonder what 'PMI' is? A simple google tells you that it is "a measure of the prevailing direction of economic trends in manufacturing". Hold on, did you say, a measure of direction of economic trend? but, aren't they all? CPI, GDP, Inflation, Exports... the list is long. Before we dive into what PMI is and more importantly, why PMI is, lets take a look at the PMI (Services) index of India.
The above chart shows us the country's PMI from the year 2012 till 2022. As you can see, currently, it stands at 57.2 points. Historically there has been a time where the PMI has even plummeted to a low of 5.4 (during the pandemic)! Now that we know its a point based measure, let's see who gives the points and to whom.
PMI was started for the first time back in1948 by US-based Institute for Supply Management (ISM).
Different countries recognize PMI indexes given by different surveyors of their choice. For example, The Singapore Institute of Purchasing and Materials Management (SIPMM) produces the index for Singapore. India (like 39 other countries) follows the index produced by IHS Markit India.
IHS Markit is a part of S & P Global (a US based company with financial information and analytics as their primary business activity).
So now that we know who gives the points, lets see what's the magic formula for these Index-makers to come up with the score. Well, as the name suggests, PMI (Purchasing Managers' Index) is based on data compiled from monthly replies to questionnaires sent to senior purchasing executives (managers) in around 400 private sector companies.
Are you a senior purchasing manager or similar, in a company whose performance makes a significant impact to the country's GDP?
Yes, and I have submitted a PMI questionnaire.
Yes, but I have never submitted a PMI questionnaire.
No, I am a Purchasing Manager or similar but not a Senior
No, I am not a Purchasing Manager/Executive.
The Index is further sub-categorized for Service Sector and Manufacturing Sector.
PMI (Services) a diffusion index calculated from a question that asks for changes in the volume of business activity compared with one month previously. For manufacturing PMI, the questionnaire is sent to manufacturing companies. The questions are factual in nature and the survey is not meant for opinions, intentions, or expectations. The questions are related to 5 key variables.
The variables with their weights in the index are — new orders (30%), output (25%), employment (20%), suppliers’ delivery times (15%) and stock of items purchased (10%). The surveys are conducted on a monthly basis.
A composite PMI is the weighted average of manufacturing and service sector PMIs for a given geography or economy, produced by IHS Markit. Weights are derived from official data relating to each sector’s contribution to GDP (value added).
The headline PMI is a number from 0 to 100. A PMI above 50 represents an expansion when compared with the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates no change.
THE MAGIC FORMULA
PMI is a diffusion index. A diffusion index is a convenient system used to convert different survey responses into a single-figure reading.
PMI = (P1 * 1) + (P2 * 0.5) + (P3 * 0)
Where:
P1 = percentage of answers reporting an improvement
P2 = percentage of answers reporting no change
P3 = percentage of answers reporting a deterioration
Questionnaires are completed in the second half of each month, and survey results are then processed by the economists. For each variable, panel members are asked to report an increase, decrease or no change compared with the previous month, and to provide reasons for any changes.
WHY PMI?
Now that the 'whats' have been addressed, lets move on to the 'whys'.
The PMI and relevant data produced monthly are critical-decision making tools for managers in a variety of roles. PMI is a good indicator of the economic activity in any country.
PMI helps everyone:
(Credit: IHS Markit)
The supplier: The suppliers follow the PMI values of a purchasing companies for the estimation of the amount of future demand for the desired products. The Purchasing Manager’s Index also allows the supplier to know how much inventory its customers have on hand and as a result, it can fluctuate its production.
The manufacturer: Assured by PMI figures, the manufacturer can accept a price increase from its suppliers during an increase in the growth rate of new orders. While, if the new orders are declining, the manufacturer has to lower its prices and demand a lower cost for the parts it purchases.
The forecaster: The PMI can be used by a company in planning the annual budget, managing staffing levels and also in forecasting cash flow.
The investor: Purchasing Manager’s Indexes are also used by the investors as a leading indicator of economic conditions. PMI plays a major role in providing useful insight into the economic activity of a business which includes the GDP, Industrial Production, and Employment.
PMI Index over GDP?
Better than government data: PMI Index is better than official government released data as government data is usually 3 months old.
Better than other indices: GDP indexes are mostly released on an annual basis. PMI is a monthly measure that helps stakeholders take prompt corrective actions.
Prevailing market conditions: PMI is released in the first week of the next month and is the first source of economic information.
Higher PMI does not always equal improving economic conditions
The pandemic era made the overall PMI index fall to 27.4 in April 2020. It would be wrong to say that we experienced V shaped recovery when the same rose to 47.2 in June 2020. The economic condition of India was just as bad (if not worse) as it was in March. The index shows the pace at which conditions improve or deteriorate compared to the previous months and not the actually economic condition of the country.
Re-interpreting the headlines!
Now that we no more need a "PMI for dummies", let's analyze the headlines. 'India's service sector Purchasing Manager's Index (PMI) has climbed up to 57.2 in August 2022, from 55.5 in July'. Service sector accounts for around 55% of India's GDP, so in this backdrop, services on the mend bodes well for India. The sector constitutes a bulk of India's economic output and sustained expansion. It might even help us to maintain our growth rate of 7%. But, uneven services spring-back may not have been captured by PMI. Transport sector is the fastest growing service sector component with a CAGR of 5.9% (2021). Other segments are yet to show buoyancy
So while PMI is good news, holistic and sustainable-growth is not yet guaranteed.
Author's suggestions:
Often times, answers reporting deteriorating conditions strike a far deeper dent than positive factors can mend. A more accurate reading should incorporate negative values (instead of zero) for declining variables. Negative points must be accorded based on the quantitative impact on the GVA of the country.
In the current PMI, qualitative factors are either put on a comparable level as quantitative factors or completely ignored. A separate monthly index for qualitative factors such that environment and social impact would be a more logical measure.
MSMEs account for around 29% of India's GDP and more than 50% of exports. The panel of purchase executives recruited(from 400 companies) for such a survey almost always fails to map the views of purchasing managers of these small enterprises. A recognized portal for authentication of all purchase managers across the country would help in a more inclusive database for the purpose of surveys. It will not only result in accurate readings but also reassure businesses of the existence of a robust mechanism for economic feedback.
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(This Article intends to educate businesses. Opinions if any, contained in the article, are strictly personal to the author and should not be considered as legal, financial or technical advice)
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