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Last week IHS Markit released Purchasing Manager’s Index (PMI) data which indicated expansion in the Indian manufacturing sector and at the same time, a contraction in the service sector. But what is PMI? How can we calculate?
Little Background:
Institute for Supply Management (ISM) started publishing PMI data for the USA from 1931 every month. Later other institutions also started publishing PMI: Singapore Institute of Purchasing and Materials Management (SIPMM), which produces the Singapore PMI, DIFL (Denmark), IVEY (Canada) and the Markit Group, which has PMI data for over 40 countries. India’s PMI is released by Markit group, now called as IHS Markit.
What and How?
PMI is a survey-based economic indicator designed to provide a timely insight into business conditions. It’s an indicator of business activity in the manufacturing and service sector. Both sectors’ PMI gets released separately. Though there are PMIs for construction and retail sectors too, manufacturing and services PMI are more closely being watched.
It is based on a monthly survey sent to senior executives/purchasing managers at around 400 private companies. The survey questionnaire for the Manufacturing sector involves factual, objective questions about New Orders, Employment, Input & Output prices, current & future output, new export orders and backlogs of work. For the service sector, the questionnaire includes questions about business activity, new business, new export business, outstanding business, prices charged, input prices, Employment and future training. The survey asks respondents to report the change in each of the above variables compared to the prior month, noting whether each has risen/improved, fallen/deteriorated or remained unchanged. There will be one additional subjective ‘sentiment’ question asking companies whether they forecast their output to be higher, the same or lower in a year.
For each of the above-mentioned variable, some of the percentage of ‘higher’ responses and half the rate of ‘no change’ responses. ‘Deteriorated’ responses are considered of zero value.
Formula:
INDEX = (Percentage of survey respondents reporting ‘higher’) *1.0 + (Percentage of survey respondents reporting ‘the same’)*0.5 + (Percentage of survey respondents reporting ‘the same’)*0.0
For example, if 100% of survey respondents reported ‘higher’ the index would be 100 (i.e 100 *1.0). If 100% of survey respondents reported ‘the same’ the index would be 50 (i.e. 100 *0.5). This index is also called as diffusion index.
What does the PMI indicate?
PMI varies between 0 and 100 with a value of 50.0 signallings no change compared to the previous month. Readings above 50.0 signal an improvement or increase for the particular sector in the last month. Readings below 50.0 signal a deterioration or decrease for the specific industry on the previous month.
PMI data is released before the official economic data. Moreover, PMI data are not revised after publication. Hence it is used by governments, financial institutions and corporates for forecasting, analysis & planning and helping to monitor critical economic variables like GDP, Manufacturing & service sector output, inflation indicators, Employment, exports, purchasing activity, etc.