Ever since government figures released on August 31 showing that India’s gross domestic product growth for the April-June quarter had slowed down considerably to 5.7% from 7.9% in the corresponding period last year, there have been intense discussions whether the destocking of goods by retailers and distributors in anticipation of the new Goods and Services Tax regime was one of the possible reasons for this slowdown. Destocking implies that retailers and distributors sold items from their inventories rather than newly produced goods.

The Goods and Services Tax, which subsumes all the indirect taxes that businesses earlier paid the Centre and states separately with the aim of creating a common market, was implemented across India from July 1. It involved a complete overhaul of the tax filing system. Ahead of its implementation, several dealers and distributors did not restock their inventories because of the confusion and uncertainty around the new tax regime.

Besides the disappointing GDP performance, in the same April-June quarter, the gross value added – a key indicator of economic activity – grew by 1.2% as compared to 10.7% in the same quarter in the 2016-’17 financial year. Both the drop in gross domestic product growth and the decline in the growth of India’s manufacturing sector continue to be seen against the backdrop of the lingering effects of demonetisation and the introduction of GST.

The argument

The debate over the destocking of goods is important from the perspective of the slowdown in manufacturing. Did destocking play a role in the slowdown, or do the reasons for the decline in growth lie elsewhere?

Those who hold the pre-GST destocking of goods as one of the factors responsible for the recent fall in GDP growth argue that lower levels of production in the April to June period was the result of members of the supply chain liquidating their inventory held over the previous quarters.

But some others countered this explanation by referring to the “change-in-stocks” data from the expenditure side of the GDP. A country’s gross domestic product can be calculated using either the expenditures or the incomes approach. In the expenditures approach, the amount paid for final goods and services is measured, while in the income approach, the income received for producing products and services is measured.

Change-in-stocks is the difference between the inventory totals for the last reporting period and the current reporting period. Some people contended that the aggregate change-in-stocks figure showed a growth of 1.2% over the last quarter, suggesting that stock levels had increased. Thus, they argued, destocking could not be blamed for the slowdown.

However, there are few problems with this approach. Changes in the aggregate figure can come from different sectors, including agriculture, mining and manufacturing. Therefore, a rise or fall in the aggregate number does not capture a sector specific picture. An industry level view is required to identify changes in inventory, specifically in manufacturing.

The analysis and findings

We conducted an industry-wide analysis to find out whether changes in production show any evidence of destocking in the April-June quarter.

Analysing change-in-stock across industries is difficult and requires a nuanced analysis of valuation and inventory cycles across industries. Even at industry level, change-in-stock only represents a discrete change in inventory at different points in time within the overall cycle of production and sales. Production, sales and change-in-stock at a firm level are interlinked, and singling out just change-in-stock in order to infer from it a slowdown in production can give misleading results.

A clear position can emerge only when production levels are analysed after accounting for sales and changes in inventory.

To get a holistic picture, we made use of the standard accounting practice that relates all our variables of interest in a single expression. We know that at a firm level: Opening stock + Production – Sales = Closing stock. As our interest was in understanding production, we rearranged the expression to denote production as: Production = (Closing stock – Opening stock) + Sales.

In this expression, the difference between closing stock and opening stock (Closing stock – Opening stock) is called the “Change in Stock”. This can be positive or negative, depending on whether inventory levels were higher at the start of the period in question, or at the end.

To be fair, we needed to adjust the production numbers for seasonal fluctuations to analyse the rise or fall in production levels across industries.

What was our estimation strategy? We identified listed firms in the manufacturing sector and made groups that broadly represent two-digit National Industrial Classification followed by the Central Statistical Organisation. This classification is an essential statistical standard for developing and maintaining a comparable database according to economic activities.

For each firm, we took data from quarterly financials on sales, opening and closing stocks and constructed the levels of production for each quarter. We seasonally adjusted the production numbers, which now encapsulates the effect of both sales and change-in-stocks and calculated the quarter-on-quarter growth. The table below shows the result of these calculations for some major sectors.

Quarterly growth in seasonally adjusted production in various industries.

The table above shows a steep decline in production in the latest quarter of April-June. Beginning April, the roll-out of GST created an uncertain environment for businesses which hampered their production. To set things in context, the Nikkei Purchasing Managers’ Index for India, a leading indicator of the economic health of the manufacturing sector, signalled a drop for three consecutive months on account of lower purchase orders to finish at a four month low in June.

The table above shows that compared to March, the slowdown in production during the pre-GST quarter of April-June is apparent in at least five major industries, including the transport sector. Together, these sectors constitute nearly 48% of the gross value added component in the manufacturing sector.

For other sectors, there could be some idiosyncratic reasons at play. For instance, production in the textile sector has a fairly large component of export demand, and to that extent, the fall in production levels seems to have been cushioned off.

Our analysis looked at seasonally adjusted production numbers that captured movements in both change-in-stocks and sales, and not just change-in-stocks. This method is therefore a more plausible approach to analyse the destocking question. The analysis shows that there is some merit in arguments attributing the slowdown in gross domestic product growth to destocking by firms ahead of GST.

Radhika Pandey, Amey Sapre, and Pramod Sinha are at the National Institute of Public Finance and Policy, New Delhi.