Economics for Everyone: Purchasing Managers' Index (PMI)

Purchasing Managers Indexes (PMI) are economic indicators derived from monthly surveys of private sector companies. The data for the index are collected through a survey of 400 purchasing managers in the manufacturing sector on different fields, namely, production level, new orders from customers, speed of supplier deliveries, inventories, order backlogs and employment level.

Aug 28, 2017 02:08 IST Universal Business School Prof. M. Guruprasad |

India’s manufacturing PMI in July hits 8-year low on GST disruption. The Nikkei India Manufacturing Purchasing Managers’ Index was at 47.9 in July, lowest since February 2009
 
Purpose
The Purchasing Managers' Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The purpose of the PMI is to provide information about current business conditions to company decision makers, analysts and purchasing managers.
 
Purchasing Managers Indexes (PMI) are economic indicators derived from monthly surveys of private sector companies. The data for the index are collected through a survey of 400 purchasing managers in the manufacturing sector on different fields, namely, production level, new orders from customers, speed of supplier deliveries, inventories, order backlogs and employment level. Respondents can report better, same or worse conditions than previous months. For all these fields the percentage of respondents that reported better conditions than the previous months is calculated. The percentages are multiplied by a weighing factor (the factors adding to 1) and are added.
 
PMI for India

For India, the PMI Data is published by Japanese firm Nikkei but compiled and constructed by Markit Economics (for the US, it is the ISM). The variables used to construct India’s PMI for manufacturing sector are: Output, New Orders, Employment, Input Costs, Output Prices, Backlogs of Work, Export Orders, Quantity of Purchases, Suppliers‟ Delivery Times, Stocks of Purchases and Stocks of Finished Goods. Similar variables are used for the construction of services PMI. A manufacturing PMI and a services PMI are prepared and published by the two. The Nikkei and Markit economics websites says that PMI data are based on monthly surveys of carefully selected companies.
 
The PMI is very closely watched, as it shows the investor sentiment in an economy’s manufacturing sector. In terms of composition, we can say the PMI is a sentiment tracking index. As indicated earlier, an indicator of the economic health of the manufacturing sector, the Purchasing Managers' Index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. An index value above 50 percent indicates a positive development in the industrial sector, whereas a value below 50 percent indicates a negative situation. Thus, a PMI of more than 50 represents expansion of the manufacturing sector when compared to the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates no change. In July 2017, the value of the Purchasing Managers' Index in India stood at 47.9 points.
 
PMI and IIP

The popular index that measures growth in the industrial sector as far as India is concerned is the CSO prepared Index of Industrial Production. IIP shows the change in production volume in major industrial subsectors like manufacturing, mining and electricity. Similarly, the IIP also gives use based (capital goods, consumer goods etc) trends in industrial production. It covers broader industrial sector compared to PMI. But compared volume based production indicator like the IIP, the PMI senses dynamic trends because of the variable it uses for the construction of the index.  For example, new orders under PMI show growth oriented positive trends and not just volume of past production that can be traced in an ordinary Index of Industrial Production. Inventory level shows recessionary or boom trends. Employment scenario is also sentimental indicator. Thus according to some experts, the PMI is more dynamic compared to a standard industrial production index.
 
Process

The two principal producers of PMIs are the Institute for Supply Management (ISM), which originated the manufacturing and non-manufacturing metrics and which produces them for the United States, and the Markit Group, which produces metrics based on ISM's work for over 30 countries worldwide.ISM and Markit Group separately compile Purchasing Managers' Index (PMI) surveys on a monthly basis by polling businesses which represent the makeup of the respective business sector. The Institute of Supply Management (ISM) generates the PMI each month. Although the ISM publishes several indexes, the PMI is the most widely followed and is sometimes referred to as the ISM index.
 
There are two parts to the monthly PMI releases: the headline PMI number, designed to provide a snapshot of the health of the economy, and the sub-indices, or component level data. The sub-indices provide insight into key economic drivers, such as inflation, exports, employment and inventories.
 
The questionnaire covers the following economic variables:
 
Manufacturing

Output, New orders, New export orders, Backlogs of work, Output prices, Input prices, Suppliers’ delivery times, Stocks of finished goods, Quantity of purchases, Stocks of purchases, Employment
 
Services

Business activity, New business, Backlogs of work, Prices charged, Input prices, Employment, Expectations for activity
 
Construction

Total activity, Residential activity, Commercial activity, Civil engineering activity, New orders, Employment, Quantity of purchases, Suppliers’ delivery times, Input prices, Sub-contractor usage, Sub-contractor availability, Sub-contractor rates, Sub-contractor quality, Future activity
 
Whole Economy

Output, New orders, New export orders, Backlogs of work, Output prices, Overall input prices, Purchase prices, Staff costs, Suppliers’ delivery times, Quantity of purchases, Stocks of purchases, employment
Headline Manufacturing PMI
 
The headline manufacturing PMI is a composite of five of the survey indices. These are new orders, Output, Employment, Suppliers' delivery times and Stocks of purchases. The ISM attributes each of these variables the same weighting when calculating the overall PMI, whereas Markit uses the following weights: New orders (0.3), Output (0.25), Employment (0.2), Suppliers' Delivery Times (0.15), and Stocks of purchases (0.1).
 
PMI data are presented in the form of a diffusion index, which is calculated as follows:
 
Where:
  • P1 = Percentage number of answers that reported an improvement.
  • P2 = Percentage number of answers that reported no change.
  • P3 = Percentage number of answers that reported a deterioration.
 
Thus, if 100% of the panel reported an improvement, the index would be 100.0. If 100% reported deterioration, the index would be zero. If 100% of the panel saw no change, the index would be 50.0 (P2 * 0.5).
 
In each country, a panel of purchasing managers is carefully selected by Markit, designed to accurately represent the true structure of the chosen sector of the economy as determined by official data. The survey panels therefore replicate the actual economy in miniature. A weighting system is also incorporated into the survey database that weights each response by company size and the relative importance of the sector in which that company operates. Particular effort is made to achieve monthly survey response rates of around 80%, ensuring that an accurate picture of business conditions is recorded over time.


 
Prospects

Purchasing managers form a near ideal survey sample base, having access to information often denied to many other managers. Due to the nature of their job function, it is important that purchasing managers are among the first to know when trading conditions, and therefore company performance, change for the better or worse.
 
Some other key benefits include
  • Timeliness- Monthly publication with PMI data released in advance of comparable official economic data
  • Comparability- Standardised data collection across economies, allowing for direct comparisons
  • Factual-Based on responses to questions on actual business conditions, rather than opinion or confidence-based measurements
  • Extensive coverage-More than 20,000 companies surveyed monthly across over 30 major developed and emerging economies
 
Impact on Management Decisions:

PMI is a critical decision-making tool for managers in a variety of roles. A manufacturer, for example, makes production decisions based on the new orders it expects from customers in future months. Those new orders drive management's purchase decisions about dozens of component parts and raw materials, such as steel and plastic. Existing inventory balances also drive the amount of production the manufacturer needs to complete to fill new orders and to keep some inventory on hand at the end of the month. Suppliers also make decisions based on PMI. A parts supplier for a manufacturer follows PMI to estimate the amount of future demand for its products. The supplier also wants to know how much inventory its customers have on hand, which also impacts the amount of production its clients must generate. PMI information about supply and demand affects the prices that suppliers can charge. If the manufacturer's new orders are growing, for example, it may raise customer prices and accept price increases from its suppliers. On the other hand, when new orders are declining, the manufacturer may have to lower its prices and demand a lower cost for the parts it purchases. A company uses all of this PMI information to plan its annual budget, staffing levels and to forecast cash flow.
 
The author is Prof. M. Guruprasad, Universal Business School

Sources: Economic Times, Markit.com, Forbes, Wikipedia, Investopedia, Guruprasad .M, Economics for Everyone Index of Industrial Production (IIP), India Infoline

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