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PMI – Decoding Purchasing Managers’ Index

What is PMI (Purchasing Managers’ Index) in Economics?

PMI Manufacturing was at 54.6 in May 22. PMI Services went up to 58.9 in May 22. Ever wondered how do these numbers get calculated?

How does the PMI get calculated?

PMI is a key indicator in the economic calendar. Most indicators in economics are lagging indicators. They tell about the economic activity after the activity has happened. For example, inflation or GDP data.

PMI on the other hand is a sort of leading indicator – indicating if economic activity is picking up.

Assume there are 100 companies. We ask the purchasing managers and supply executives from these companies about economic activity in various segments. The primary question asked is if the economic activity improved as compared to the previous month.

There could be 3 answers – Improvement, No change, or Deterioration.

Assume the percentage of people who said economic activity improved is P1, those who mentioned No Change was P2 and those who said it deteriorated is P3

Mathematical Equation

Then we use a mathematical equation to arrive at the Purchasing Managers’ Index

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

If everyone said economic activity deteriorated, we will get PMI = 0. If everyone said there was improvement, PMI = 100. The central point of this data is 50, when everyone says there is no change in economic activity.

Now interpret the data. If more people say that economic activity improved, then the PMI will be above 50 (expansion zone). On the contrary, if more people choose deterioration, PMI would be below 50 (contraction zone).

So yup, that is how you calculate the PMI

Assume P1 = 40, P2 = 30, P3 = 30. You will calculate and find PMI to be 55. More people believe economic activity is improving, as compared to those who feel it is deteriorating.

Change the numbers to P1 =  30, P2 = 30, P3 = 40, you will see PMI will be 45. Now the economy is in contraction zone, since more people believe it is deteriorating.

And then you observe trends. If PMI reading goes from 57 to 53, there still are more people who believe improvement is happening as compared to those who think deterioration is happening. However, the number of people saying improvement is lesser when compared to last month. Similarly, if the PMI goes from 45 to 48, it is still in contraction zone, but the number of people who believe economic conditions are deteriorating would have reduced. Markets focus more on these trends than the actual number.

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