Column: Manufacturing slump drags services

Updated: Oct 5 2013, 10:01am hrs
When the Central Statistical Organisation released the first-quarter estimate of GDP growth last month, the stagnation in industrial production, with a contraction in manufacturing output, caught most of the attention.

What came as a bigger surprise, however, was the sustained slowdown in the services sector, which drives almost 58% of Indias GDP.

The global economic slowdown has often been cited as being majorly responsible for the decline in Indias services sector output. But this is only partially true, because the bulk of the slowdown is home-grown.

As the accompanying chart shows, domestic demand-dependent sectors today contribute more than 90% of the services sector output. And since FY12, growth in these largely domestic-demand-dependent sectors has slowed sharply, bringing down overall services growth to average 7.7% in FY12 and FY13. Thats nearly a 200-basis-point fall from the 9-10% rates seen through the second half of the last decade.

Sectors such as trade, hotels & restaurants, transport, communication, and real-estate services saw average growth falling more than 500 basis points to nearly 8.5% from 14.5%.

While the weak external environment contributed, the dominant reason was the prolonged decline in industrial growth and slippage in private consumption.

Looking back, Indias services sector story really took off in the 1990s. Over time, all its sub-sectors outpaced overall GDP growth, with the fastest ones driven by domestic demand. To be sure, high growth in information technology services played a significant role during this decade.

In other words, the story emerged in response to both rising domestic demand for services as industry started picking up, and the opportunities germinating abroad.

Now cut to the current milieu: while industry is looking down, growth fatigue has caught up with services. Conversely, the global setting is much better than what it was at the height of the financial crisis 4-5 years back.

Services sector growth, which once nudged 10%, fell to 7.1% last fiscal, which was the lowest in a decade. The weakness continues, with the first quarter coming up with 6.6%; the trend is unlikely to improve this fiscal.

Once again, the drag emanates from a steep decline in domestic-linked businesses such as trade, hotels, transport and communication, which contribute close to half of the services sector output. This segment, which had grown at an average 8.7% in the past five years, fell to a low of 3.9% in the first quarter of the current fiscal.

Another interesting insight is gleaned from the community, personal and social services (CP&S) segment, that is entirely driven domestically. Here, the public sector component has fallen primarily due to the withdrawal of stimulus and the waning effect of Pay Commission hikes.

Overall, private-sector services slowed to 8.4% in FY12 from a peak of 12.3% in FY06. But, contrastingly, some of their constituents saw a massive pick-up, such as coaching centres, membership organisations (industry associations, professional bodies, religious outfits and clubs), recreation and entertainment, radio and TV broadcasting, custom tailoring, etc. These galloped 9-19% in real terms in FY12.

The weakness in industry (growth fell to 3.5% in FY12 and further to 2.1% in FY13) and household consumption has hurt demand for services.

Estimates for the first quarter of this fiscal suggest that industrial growth barely managed to stay above 0%. If one takes out the contribution from the construction sector, industry growth actually contracted by 0.9%. That compares with the trend rate of 8% in industry.

Over the years, inter-linkages between industry and the services sector have strengthened rapidly. Input-output data suggest that producing one unit of industrial output required 0.44 units of services in FY08 compared with 0.36 units in 1998-99.

The linkages with the manufacturing sector are also quite strong. To produce one unit of manufacturing output required 0.34 units of services in FY08 versus 0.25 units in 1998-99. With manufacturing posting a contraction in the first quarter, and unlikely to expand much through the fiscal, the prospects for the service sector, too, stand diminished.

And within the sector, business serviceswhich have a share of 8% in services GDPis most exposed to external demand, but has been relatively resilient in the recent past. IT/ITES (which have a 72% share in business services), grew 12% in FY12 after a sluggish 5% in FY10 and FY11.

In this fiscal, this sub-sector is expected to see a further pick-up supported by improved global conditions and a depreciating rupee, which aid exporters. Others within business services, which include real estate, dwelling and legal services, have also seen continued resilience.

These sub-sectors have had a high and stable growth of 16-18% between FY06 and FY12. As a result, the share of business services in services GDP rose to 7.9% by FY12 from about 5.5% in FY06. This is another indicator showing the decline in services growth is less attributable to external factors.

Net-net, the sharp slowdown in services sector growth is a grim reminder that when industry is not doing well, services cannot remain unaffected.

Indias industrial slowdown is mainly policy-led unlike the services sector, where sluggishness is the result of lower domestic demand. A recovery in the services sector, therefore, hinges on removing policy bottlenecks to revive industrial growth.

Dipti Deshpande

The author is economist, CRISIL