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GOING BEYOND the headline number, the stellar second quarter Gross Domestic Product (GDP) number presents a mixed bag of sorts: unexpected tailwinds that aided growth during the three month period, and some potential headwinds going forward.
Improved corporate profitability driven by the slide in input prices, a sharp surge in construction activity helped mainly by government-led capital expenditure, alongside some deflator-related issues in accounting — these were some of the factors which were underestimated by most economists in their GDP estimates for the July-September quarter. The result — a stellar 7.6 per cent growth rate, which has prompted most economists to revise up their growth forecast for FY24, even as they underlined the perceptible moderation in private consumption and concerns of a slowdown in the remaining half of the financial year (October-March).
The consensus estimates for GDP for July-September (Q2) had ranged between 6.7-7 per cent, with a few economists pegging it closer to 7 per cent. Multiple economists that The Indian Express spoke to after the GDP data release admitted that manufacturing and construction growth for Q2 came in much higher than expected. For FY24, economists are now projecting a growth rate between 6.2-7.0 per cent. Both the Reserve Bank of India (RBI) and the government have projected a growth rate of 6.5 per cent for the financial year 2023-24.
“Manufacturing growth has come stronger-than-expected, with higher corporate margins seen in Q2. We are now expecting 7 per cent plus growth in FY24, with 6-6.5 per cent growth in the second half of the year,” State Bank of India’s Group Chief Economic Adviser Soumya Kanti Ghosh said. India’s manufacturing sector grew at a robust pace of 13.9 per cent, compared to 4.7 per cent in Q1FY24 and (-)3.8 per cent in Q2FY23.
Another dataset released Thursday — the RBI’s data on ‘Performance of Private Corporate Business Sector during Q2:2023-24’ drawn from quarterly financial results of 2,835 listed non-government non-financial companies — substantiated the pickup in corporate profitability in the manufacturing vis-a-vis services sector in the second quarter. The RBI data showed that profitability of manufacturing companies based on EBITDA-to-sales ratio increased to 17.2 per cent in Q2 FY24 from 16.1 per cent in Q1 and 14.6 per cent in the year-ago period. Meanwhile, the EBITDA-to-sales ratio for services (non-IT) sector companies moderated to 24.8 per cent in Q2 from 26.5 per cent in Q1 but was higher than 21.2 per cent in Q2 FY23, and that for IT sector companies was 26.5 per cent in Q2 FY24 as against 25.6 per cent in Q1 and 26.5 per cent in the year-ago period.
The divergence between manufacturing and services sector growth was reflected in the GDP data as well — manufacturing growth rose to double digits (nine-quarter high of 13.9 per cent) while services growth moderated (5.8 per cent), a departure from the services-driven trend seen over the last few quarters. “This could be a signal that some normalisation in service demand and rebalancing towards goods demand is now underway,” HDFC Bank’s Treasury Research said in a note.
Another significant factor which pushed up the Q2 GDP growth was the front loading of capital expenditure by states and Centre. Economists pointed out that the government played the primary role in lifting consumption and investment numbers amid weaker private consumption and missing broad-based signs of private capex, even as investment-to-GDP ratio rose to a 12-year high of 35.3 per cent.
“The positive factors are construction, manufacturing and investment growth. One factor which may also be favourable is that with declining inflation, even with the same nominal wage growth, it will give a boost to real wage growth,” Devendra Kumar Pant, Chief Economist, India Ratings and Research said.
“The government appears to be in the driver’s seat – both for consumption and investment – while private consumption and private capex remain weak, in our view. Lower commodity prices have also boosted firm profits, implying a major growth tailwind due to terms of trade,” a note by Nomura’s research analysts Sonal Varma and Aurodeep Nandi stated.
The construction sector, which is one of the biggest sources of employment in the country, also reflected part of the impact of the higher government spending, growing by 13.3 per cent in Q2, a five-quarter high rate of growth. After the release of the GDP data Thursday, Chief Economic Adviser V Ananth Nageswaran had said that construction activity is “looking quite good”, adding that “it is something which did not do as well in the second decade, therefore, the momentum has just started and one should see it continue.” The CEA also said that India’s GDP growth may be getting understated rather than overstated, adding that the growth momentum is expected to continue in the October-December quarter also.
Some part of the uptrend in manufacturing was also attributed to statistical impact from the deflator (nominal divided by real – a measure of inflation), with manufacturing deflator being negative in Q2 as wholesale inflation (WPI) was negative in the quarter. “This could have pushed up the real GDP growth figures as real GDP numbers are derived at, for certain categories in the GDP data, by deflating nominal activity indicators. There were also base effects at play that pushed up manufacturing, construction, and electricity growth,” the HDFC Bank note said.
IDFC FIRST Bank’s Economist Gaura Sengupta said the deflator, with a higher weight of WPI, was favourable for manufacturing than the services sector, which has a higher weight of Consumer Price Index (CPI) inflation. “Corporate profits have done really well and that has also helped tax collections,” she said. With GDP deflator rising to 1.4 per cent in Q2 from 0.2 per cent in Q1, the nominal GDP growth rose to 9.1 per cent in Q2 from 8.0 per cent in Q1.
The headwinds that threaten the outlook
Muted private consumption amid a moderation in income growth and the lack of a pickup in services are weighing as concerns for growth going ahead. Government expenditure, a key driver of growth, is also expected to slow down ahead of elections. And slowing farm indicators are an added worry.
A fuller transmission of the monetary policy, which essentially means pass-through of the central bank’s rate hikes to consumers by banks, is also expected to temper domestic demand, as was pointed out by the Finance Ministry in its latest monthly economic review for October 2023 released last week.
-“With more than half of the current financial year witnessing positive developments in the economy, the full financial year should conclude as projected with a strong growth performance and macroeconomic stability. Yet risks on the downside persist. Inflation is one of them that has kept both the government and the RBI on high alert. Financial flows in the external sector also need constant monitoring as they impact the value of rupee and the balance of payments. A fuller transmission of the monetary policy may also temper domestic demand,” the Ministry report had said.
When asked about this, the CEA on Thursday said the risks are likely to keep growth rates closer to the earlier projections rather than seeing an upside like Q2. “Earlier the expectation was only 6.5 per cent but now we are at 7.6 per cent…it is possible that what the higher risk weights do plus monetary policy transmission do is to keep the growth rates as projected earlier rather than see an uptick as we have seen in the second quarter,” he said.
As per the latest monetary policy statement by the RBI, real GDP growth for 2023-24 is projected at 6.5 per cent, with Q2 at 6.5 per cent, Q3 at 6 per cent, and Q4 at 5.7 per cent, with risks evenly balanced.
“Private final consumption growth is lacklustre, and agricultural growth is slow. These are the concerns,” India Ratings’ Pant said.
A weakness in consumption demand has been visible in the services sector, with the contact-intensive sector of ‘trade, hotels, transport, communication and broadcasting-related services’ growing 4.3 per cent in Q2, slower from 15.6 per cent in the year-ago period and 9.2 per cent in the previous quarter. Financial, real estate and professional services grew 6.0 per cent in Q2 as against 12.2 per cent growth in the previous quarter and 7.1 per cent in the year-ago period. The recent RBI measures to curb unsecured lending are expected to dampen consumption demand to some extent going ahead.
Concerns are also there for the agricultural sector, which already slipped to an 18-quarter low of 1.2 per cent in July-September, reflecting the impact of erratic rainfall on Kharif output. Any impact on the winter crop will affect the agricultural growth that will, in turn, have an impact on the rural wage growth and demand as well.
In addition, government expenditure is also expected to slow down ahead of elections. “GDP growth in H2FY24 is expected to moderate, in large part due to waning support from base effects. Growth momentum is expected to moderate as companies profit growth slows, with rise in input cost pressures. Recovery in rural demand has remained mixed due to relatively softer pace of rural wage growth and uneven monsoon. Support for the capex cycle from government expenditure (Centre and states) could reduce in H2, ahead of the elections,” Sen Gupta said.
Government consumption spending in Q2 rose to 12.4 per cent year-on-year as against (-) 0.7 per cent in Q1, while private consumption growth moderated to 3.1 per cent in Q2 from 6.0 per cent in Q1, with likely impact of higher inflation on real incomes. Net exports continued to remain a drag in Q2, with imports growing faster than exports during the quarter.
Nomura, which raised its FY24 growth forecast to 6.7 per cent from 5.9 per cent previously, said it will maintain its expectation of a moderation of GDP growth to 5.6 per cent in FY25, due to a slowdown in public capex ahead of the election, continued sluggishness in rural demand and private capex, waning terms of trade tailwind, and a synchronised global growth slowdown.
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