Base-effect hallucinations

Corporate results in July-September 2015 were rather disappointing. Across a sample of 1,600 odd companies (with a cut-off minimum sales of ₹10 crore), total sales fell by 4.8 per cent. Looking a little deeper, raw material costs fell by 23 per cent and the cost of purchased goods fell by 10 per cent. Interest outgo increased by 5.7 per cent. Net profits dropped by 2 per cent and PBDIT was up by 1.9 per cent. The easiest and most popular way to judge trends in a particular variable is to compare the latest values to the values taken a year ago (sometimes a quarter ago). But if the initial base value is unusually high or low, that year-on-year change may be somewhat misleading. Due to the potential for distortion time-series variables such as inflation indices, index of industrial production, exports, imports, etc., must all be treated with caution. For example, take a look at crude prices over the past couple of years. The international price of oil was around $45/barrel of Brent-grade crude by November 2015, down from over $100/barrel in early 2014. So, the trend has very clearly been negative. But the base effect overstates the downtrend. Crude prices started falling in September 2014, towards the end of the July-September quarter. In July 2014, Brent was trading at around $110/barrel and it traded at around $95 in late September. So, the prices were pretty high through that period, averaging about $102. In the corresponding quarter of July-September 2015, prices averaged around $50.45. A pure YoY comparison would suggest that crude was trending steeply down due to the base effect. As the price chart

This article was originally published on December 24, 2015.