India’s growth rebounds, eyes on headwinds
Guest Column: Radhika Rao, Economist, DBS Group Research

The Indian economy expanded 7.2 per cent YoY in October-December (Q3 FY18) – a five-quarter high and from an upwardly revised 6.5 per cent in Q2. On the sectoral end, gross value-added (GVA) growth rose to 6.7 per cent from a revised 6.1 per cent in the September 2017 quarter. Base effects were notable as economic activity was depressed due to the after-effects of the large-scale currency ban, same time last year.

Digging into details, Q3 FY18 expenditure and sectoral breakdown revealed three encouraging aspects, whilst three disappointed.

Looking at the positives:  Firstly, the sharp improvement in capital formation was a notable surprise. Gross fixed capital formation (GFCF) rose 12 per cent from H1’s 4.3 per cent, alongside inventories re-stocking after the dust settled following the GST rollout. As corporate sector deleveraging progresses at a gradual pace, higher government capex spending and central public sector enterprises’ (CPSEs) participation are likely behind this improvement. As a percentage of GDP in current prices, GFCF ticked up to 28.7 per cent from 27.9 per cent in the comparable year ago period.

Secondly, industrial production benefitted from a firmer manufacturing sector (restocking and festive demand) and rebound in construction activity. The latter, combined with a pick-up in agricultural growth, partly allays concerns over the performance of labour-intensive industries. For the year ahead, the outlook still hinges on the efficiency of rural support measures and spatial/ geographical spread of the crucial southwest monsoon.

Lastly, core GVA (ex-agri, public administration), which provides a sense of the underlying growth momentum, accelerated for a second consecutive quarter to 7.4 per cent vs 6 per cent in H1.

On the other hand, the main dampener was the moderation in the economy’s key growth driver - private consumption, which slowed to 5.7 per cent vs H1 FY18’s 7 per cent.

This was likely weighed down by subdued rural demand as real wage growth has been moderating, alongside a supply glut that has depressed prices. The recently announced increase in minimum support prices (MSPs) and rural reforms, along with a timely monsoon, are expected to buttress consumption trends. The second was the sharply weaker net trade balance, which emerged as a significant drag on growth. The trade deficit widened to -3.1 per cent of GDP from Q2’s -1.2 per cent. A bigger commodity bill, higher investment imports, and a shortfall in domestic electronic production, ballooned the imports bill. But exports remained subdued due to domestic idiosyncrasies and a lack of competitiveness in labour-intensive industries. A wider trade gap will also underpin worries over external stability as this year’s current account deficit is set to widen to above 2 per cent of GDP.

Finally, the wedge between real GDP and GVA widened in Q3 due to higher net indirect tax collections. Base effects have also been favourable as the comparable year ago period witnessed a drop in receipts (see the chart). As GST collections stabilise and base effects dissipate, this wedge is likely to narrow. For the time being, nonetheless, GVA growth continues to provide a good sense of growth trends, suggesting that the economy’s pulse rate is improving gradually. Additionally, nominal GDP growth got a boost from higher real growth and wider GDP deflators, which means that in the short-term, key macro ratios are in a better shape than feared.

Outlook remains positive

Growth is likely to remain firm around the 7 per cent handle in the March 2018 quarter (Q4 FY18), as the impact of twin disruptive reforms – demonetisation and GST – roll off. This should keep full-year real GDP growth close to our projection of 6.6 per cent and GVA at 6.4 per cent in FY18, with official estimates also aligning toward our forecast.

FY19 is likely to benefit from pre-election spending and an anticipated pick-up in rural incomes (if MSP increases are substantial). Nonetheless, the drag from a slower banking sector clean-up and, by extension, deleveraging by corporates in the midst of rising input costs, suggest that a V-shaped recovery will be a challenge. We expect growth to tick-up to 7.2 per cent YoY and GVA to 6.8 per cent in FY19, more conservative than consensus at this juncture.

Policy implications

In the short-term, these strong growth numbers are likely to provide relief amid heightened market volatility and jitters in the domestic asset markets. Beyond the near-term optimism, debt markets are likely to pay attention to the likely policy path – to this end, stronger growth numbers lower the bar for the Reserve Bank of India (RBI) to shift from a neutral to a hawkish stance, if inflation proves sticky beyond June.

That said, a rate hike at the next monetary policy meetings in April/June is not a done deal. The RBI’s stated intention to look past the better data in H1 2018 suggests that policymakers have yet to be fully confident about recovery prospects. Our base case scenario sees the RBI holding rates steady for the time being, with a hike coming only in Q4 FY19. If the hike is brought forward, it will probably come in the September quarter (Q2 FY19). This would have to be driven by sharp increases in the Minimum Support Prices keeping inflation sticky above 5 per cent beyond June 2018, more so if accompanied by high oil prices and heightened market volatility, especially in the Indian rupee.