India’s growth in a sweet spot
The Q1 GDP data ironically bodes well for the economy, even though the growth rate at 6.8% is lower than last year. The main reason for optimism is, it does appear that most of the boxes which represent the prerequisites for high stable growth of above 7% for the year have been ticked.
The seeming contradiction can be explained by the internals of the numbers. GDP is defined as the sum of gross value added (GVA) and net taxes. GVA is the actual growth in production in different sectors that are represented by eight segments. The movement from GVA to GDP is based on the net addition of taxes — the difference between commodity taxes (mainly goods and services tax) and subsidies.
The growth estimates for Q1 were always going to have a downward bias due to the base effect of higher growth last year. The 8.4% growth last year provided this base effect. When one looks at the growth in GVA, there is a lot of comfort as it was 6.8%. This means that GDP growth was lowered to 6.7% due to low growth in the “net taxes” component. This was on expected lines and most sectors witnessed growth roughly as forecast.
There were two positive surprises. The first was manufacturing, which did better than expected notwithstanding that corporate profitability has been low-key this quarter. Gross profits, it should be mentioned, is an important component of value added, with salaries and wages being the other component. The 7% growth is a good sign because as demand moves in the upper trajectory, this level of performance can be sustained. The second is the “public administration, defence, and other services” component, which grew by 9.5%.
The negative surprise was agriculture and allied activities, which grew by just 2%. A higher number could have been expected because the rabi crop was very good last year. It appears the party was spoilt by heatwaves which affected the “allied activities” that include horticulture, besides fodder, animal husbandry, etc. With the monsoon being normal, there should be a reversal in some of these trends.
There have been several encouraging signs in this data set. To begin with, growth in consumption was impressive at 12.4%, the highest since Q2 of FY22 when pent-up demand pushed up growth to a high of 17.5%. This is important because consumption has been one of the missing links to the growth story. Here, rural demand has lagged; and the argument put across often is that high inflation and lower income have stymied demand. This has changed of late, with inflation also seemingly coming under control at less than 5%. Urban demand so far has largely been confined to the premium segment, but this could be changing going by the data.
The second engine that has started to fire is investment. There have been divided views on whether the private sector has started spending on investment. Reserve Bank of India (RBI) data does show some increase in capacity utilisation by March, but this could be a seasonal factor as the rate tends to peak before dipping in June. Growth at 8.8% in gross capital formation and 9.1% in gross fixed capital formation is quite impressive. As the government spending on capex was muted due to the elections this quarter, it can be concluded that most of this growth was in the private sector. Therefore, the GDP growth number of 6.7% is more than satisfying.
What can be the reason for optimism with this growth rate? The government has projected 6.5-7% growth for the year, while the RBI is looking at 7.2%. The latter looks more likely as conditions are favourable. First, the consumption story should work out even better in the coming months. The rains have been more than favourable and sowing data shows that the kharif crop, with the exception of cotton, would be generally better than last year. This means food prices should get tempered. While it may take time to get reflected in the inflation numbers, it would still mean higher rural income.
Second, given that consumption will be increasing and that will lead to better capacity utilisation, the pace of capital formation should also improve. This in turn should lead to some improvements in investment in the consumer goods segment. So far, most of the investment has been in infrastructure-oriented companies. It may be expected to become more broad-based during the rest of the year. Add to this the government capex programme, which will accelerate as already seen in July, and this will ensure overall capital formation gets a boost.
Lastly, on the production side, with GVA on track, the net taxes will hold a clue to faster growth. In the first quarter, tax collections were buoyant. However, subsidy outflows were front-loaded to an extent. This will get corrected along the way, and hence the net tax collection growth, which was muted in Q1, will return to normal.
Therefore, there are strong indications that growth in the economy will be strengthened further. There are also emerging possibilities of the RBI lowering the repo rate, which could be in the fourth quarter provided inflation looks subdued. This can be a positive for industry, at a time when investment looks to improve. It can be said that the Indian economy is truly in a sweet spot for growth and can maintain a number of above 7% this year and move further upwards thereafter.