What is PMI and why is it important?

The Purchasing Managers’ Index (PMI) has been in news all through the last two weeks. Many countries across the world released their PMI numbers for the month of May – which determined the trend in their stock markets.

So, what is PMI?

The PMI is considered as a measure of the ongoing direction of economic trends in the manufacturing sector in a specific region. Calculated on a monthly basis, the PMI is based on a survey of various supply chain managers.

How is the PMI calculated?

The index number ranges from 0 to 100. In case of the PMI, the threshold mark is 50, from an economic point of view. Any PMI below 50 represents contraction on a sequential basis in the manufacturing activity, while any PMI above 50 represents an expansion. A reading of 50 represents no change. The formulae for calculating the PMI are:

PMI = (P1 * 1) + (P2 * 0.5) + (P3 * 0)

In this case:

P1 = the percentage of respondents reporting an improvement 

P2 = the percentage reporting no change

P3 = the percentage of answers reporting a deterioration

Who compiles the PMI?

The PMI is based on a monthly survey of supply chain managers across 19 industries, covering both upstream and downstream activities. In the US, the PMI is released by the Institute for Supply Management (ISM). However, it is not just the ISM that releases the PMI numbers. Some of the other companies also produce the PMI numbers, like IHS Markit Group, which puts out the PMI for various countries outside the US. In the far east, Japan’s Nikkei also releases to PMI numbers regularly.

How does it impact policy makings?

It gets governments up to speed with the direction towards which the crucial manufacturing sector is going. So, it helps them in taking calls and intervening in the right time. Suppliers also take calls based on the PMI numbers -- in a bid to estimate the amount of future demand. Investors use the PMI to their advantage because it is a major indicator of economic conditions. In short, the early signs of an economic slowdown are reflected by the PMI itself.

How is PMI different from GDP?

Both PMI and GDP denote the major economic direction of the country. However, the difference lies at the basic level. While the GDP is a measure of all the goods and services produced within a geographic area, the PMI is always focused on the manufacturing activity. Another most important factor is the time allocation. This PMI is more real-time than the GDP. The GDP, on the other hand, is backdated by at least two months.