The surge in GDP growth to 7.8 per cent in the first quarter is no surprise. Most high-frequency indicators, including the Purchasing Managers Index (PMI) for goods and services and credit growth data already pointed to fast growth. The weakness in exports, which contracted by 6.3 per cent during the period, did not dent the momentum much.
But manufacturing was a bit disappointing, given that PMI for manufacturing was in a strong expansion zone, and corporate profits for the quarter were healthy. Construction surged 7.9 per cent over a high base, and on the back of government capital expenditure (capex), a pick up in real estate activity and lower input prices. That is likely to have spurred employment growth in construction — a labour-intensive sector.
On the demand side, the investment to GDP ratio was at a healthy 34.7 per cent – similar to last year. The front-loading of the Centre’s aggressive budgeted spending target, along with a sharp rise in spending by states has helped. Spending by the Centre grew at a massive 59 per cent, and for 16 major states, it rose 76 per cent. But unlike central government capex, the high state capex growth was over a very weak base.
The sobering part of this analysis is the government cannot keep pumping up investments at the current rate beyond this fiscal as it needs to stick to its fiscal consolidation path. The private sector will have to take up the investment baton from the government for growth to continue. But, the good part is, conditions for that are turning conducive. Private companies have cleaned up their balance sheets and are ready to re-leverage and drive the investment cycle. The government’s continued focus on infrastructure creation will keep improving connectivity and lower logistics costs, helping to “crowd-in” private investment.
Moreover, according to the RBI’s surveys, capacity utilisation in the manufacturing sector was at 76.3 per cent, above its long-period average. CRISIL’s estimates confirm this trend.
The Production-Linked Incentive (PLI) schemes could help fast-forward private investments in specific manufacturing sectors over the next few years. The West’s desire to diversify global supply chains away from China presents good opportunities. Sectors such as steel and cement, which are linked to infrastructure development, and some others such as petroleum products and aluminum are seeing a notable pick-up in investment activity.
For other items, the demand situation is less clear. Given this, public investment thrust is likely to continue this year.
Alongside, private consumption grew at 6 per cent over a high base. Most of this comes from the urban economy, where services growth rose sharply. Nearly two-thirds of services are urban-centric. Additionally, private corporate sector salaries are expected to grow at around 10 per cent this fiscal, which will support urban consumption.
In contrast, the rural economy is seeing flat wages, weak demand under the Mahatma Gandhi Rural Employment Guarantee Act (due to movement of labour to urban areas) and risks to agricultural output from weather vagaries.
However, there are indications that the 7.8 per cent growth in the first quarter would be the peak performance for this fiscal.
In the current July-September quarter, private consumption demand could weaken sequentially because high food inflation is bound to wither discretionary spending power. While inflation is likely to soften by the third quarter of this fiscal, it will entirely depend on responsive supply-side measures to bring down cereal prices, and the seasonal arrival of vegetables, which will lower prices over the next two months. Tomato prices have already cooled.
In the second half, other headwinds would come into play, all of which could impact demand and industrial production. One is the slowdown in the West, particularly Europe. Though major advanced economies have remained resilient in the first half of this year, S&P Global expects a shallower but more protracted slowdown as interest rates stay elevated for longer. Europe will see a sharper downturn with interest rate hikes, cost of living shocks and adverse geopolitical factors.
For India, the poor showing on merchandise exports, which has contracted in each of the past six months, will also weigh on manufacturing sector growth. While the decline in exports growth is price-led, volumes are also falling for some. Data from the Ministry of Commerce and Industry shows export volume in 40 out of 74 commodities fell in April-June 2023. According to an S&P Global and GEP study, European supply-chain spare capacity was at its highest since the global financial crisis pointing towards deteriorating conditions there.
Intriguingly, India’s goods exports face stronger headwinds from the Asia-Pacific region than the West. These could worsen as both Asia and the west are expected to decelerate in the second half of this fiscal. So, despite the cushion from services exports, overall exports are on a decline this fiscal, which would weigh on domestic production sectors that serve this constituency.
Two, the peak impact of the series of rate hikes by the RBI will play out from now. The repo rate has been raised 250 basis points since April 2022 to tame inflation.The established thesis is that rate hikes first moderate growth before they impact inflation.
Three, the monsoon continues to play truant. After a deficient June and above-normal July, rains have again slipped below the long period average (LPA). August, which is critical from an agricultural perspective, has seen a severe deficiency of 36 per cent below LPA. With El Niño conditions getting entrenched, rains in the rest of the season have become crucial to lift agricultural output and rural demand and subdue inflation. Rains also influence groundwater and reservoir levels for the rabi crops, which are largely irrigated. On a positive note, the Indian Metrological Department expects rains to pick up in September.
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The amplified risk to agricultural output and prices is visible in the government’s proactive and reactive measures to shore up supplies — ranging from announcements of export bans/export tariffs, stocking limits, imports of pulses and market intervention at lower prices.
Finally, nominal GDP was only 20 basis points higher than the real growth because of deflation in wholesale prices and low consumer price inflation in the first quarter. If sustained, slower nominal GDP growth can weaken tax collections.
We expect GDP growth to slow to 6 per cent in the current fiscal from 7.2 per cent the previous year. Even so, expect India to be the fastest-growing G20 economy this year.
The writer is Chief Economist, CRISIL Ltd