What is Purchasing Managers’ Index (PMI)?

Calculation of Purchasing Managers’ Index

Introduction

Purchasing Managers’ Index (PMI) has become one of the most closely watched indicators of business activity in the manufacturing and services sector across the world. In this article, we will discuss what is PMI, how to calculate it, How does one read PMI numbers etc.

What is Purchasing Managers’ Index (PMI)?

• The Purchasing Managers’ Index (PMI) is an indicator of the economic health of the manufacturing and services sector. It indicates the growth level and growth potential for manufacturing and services sector in a country.
• It is a survey-based measures that asks the respondents about changes in their perception of some key business variables from the month before.
• It is calculated separately for the manufacturing and services sectors and then a composite index is constructed. 
• 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.
• Index measures the performance of the manufacturing sector and is derived from a survey of 500 manufacturing companies.

Calculation of Purchasing Managers’ Index

• The PMI is derived from a series of qualitative questions. Executives from a reasonably big sample, running into hundreds of firms, are asked whether the above mentioned key indicators such as new orders, output, business expectations and employment were stronger than the month before and are asked to rate them.
• In each country, a panel of purchasing managers is carefully selected and 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. 

The questionnaire covers the following economic variables:

• Thus, the PMI is calculated monthly and is observed by the domestic as well as international investors. 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.
• PMI is based on five individual indexes with the following weights: New Orders (30%), Output (25%), Employment (20%), Suppliers’ Delivery Times (15%) and Stock of Items Purchased (10%)
• Purchasing Managers’ Index (PMI) is calculated as follows:
• PMI = (P₁ * 1) + (P₂ * 0.5) + (P₃ * 0)

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 a deterioration, the index would be zero. If 100% of the panel saw no change, the index would be 50.0 (P₂ * 0.5).

How does one read PMI numbers?

• PMI = 50, denotes there is no change in business activity. A PMI index of 50 would arise if either all respondents reported no change or the number of respondents reporting an improvement was matched by the number of respondents reporting a deterioration.
• PMI > 50, denotes expansion/improvement in business activity.
• PMI < 50, denotes contraction/deterioration in business activity.
• Higher the difference from the number 50, greater the expansion or contraction. The rate of expansion can also be judged by comparing the PMI with that of the previous month data.
• If the PMI figure is higher than the previous month’s then the economy is expanding at a faster rate. If it is lower than the previous month then it is growing at a lower rate
• If manufacturing is expanding, the general economy should be doing likewise. As such, it is considered a good indicator of future GDP levels. Many economists will adjust their GDP estimates after reading the PMI report. 

Key benefits of Purchasing Managers’ Index (PMI)

1. Timeliness : Access a monthly publication of PMI data in advance of comparable official economic data
2. Comparability : Make direct comparisons of economies with standardized data
3. Factual sources : Use data based on responses to questions regarding actual business conditions, rather than opinion or confidence-based measurements
4. Extensive coverage : Rely on survey depth, with more than 26,000 companies surveyed monthly from more than 40 major developed and emerging economies