Numerically we are on the right path and stronger numbers may be expected partly due to negative deflators
The Q2FY16 GDP numbers have brought cheer to the market, as these came at a time when we needed assurance that the economy is on the upward path. Being the most comprehensive indicator of the health of the economy, the GDP numbers, notwithstanding the unresolved controversy on the methodology being used, are a reasonable leading indicator. The numbers for Q2 are interesting and one can draw at least 10 takeaways from the data.
First, a growth rate of 7.4% in the second quarter, which is also a relatively lean period, bodes well for the next two quarters—it means that an overall growth rate of 7.5% for the year cannot be ruled out given that the main season, once called the busy season, starts from the onset of Q3.
Second, the growth in nominal GDP at current prices comes in lower at 6%, with a cumulative growth of 7.4% against 13.5% last year. This is a conundrum for two reasons. The first is that while normally growth at current prices is higher than that in real terms, on account of negative inflation going by the GDP deflator or WPI, we have an anomalous situation where real growth numbers would always be better than those in nominal terms. This is on account of the price adjustment, which is negative. The other outcome is that all economic ratios that are monitored which are juxtaposed with GDP in nominal terms will tend to get skewed. For example, the fiscal deficit was to be 3.9% of GDP, assuming 11.5% growth in nominal GDP in FY16. If growth is lower at, say, 7.5%, then the fiscal deficit has to be pruned by Rs 25,000 crore to maintain this ratio.
Third, the relationship between industrial growth across sectors in IIP and value added in corresponding components in GDP is interesting. In case of manufacturing, growth of 4.6% in physical terms goes with 9.3% growth in value added, indicating a multiple of 2. In case of mining, 2.7% growth in IIP leads to 3.2% in GVA, a multiple of 1.2, while for electricity the multiple is unity with both the growth rates being 6.8%. The conclusion is that there is evidently more value addition coming from the manufacturing sector, and the other two conventional infra industries do generate this value addition even though they involve large investment.
Fourth, the first two quarters are free from the influence of the monsoon and its impact on farm output. As the kharif season starts from October onwards, the impact of lower output will come in Q3. Also, Q4 is critical as most of the rabi crop is harvested. Therefore, the negative impact of lower kharif agricultural output is to be felt in the second half of the year.
Fifth, the construction sector has grown by just 2.6%, which comes as a disappointment as there were expectations that there were big bang investments coming from the government in roads and railways. It has not happened so far, but there is hope that if these assignments are finalised, there could be heightened activity in subsequent quarters. This means the movement in previously stalled projects in the construction space has not been significant as issues beyond permissions have come in the way.
Sixth, the segment trade, transport and communications has shown a healthy growth rate of 10.6%, which has been attributed more to the trade sector where high growth in sales tax collections has contributed to the same. Here, given that the nominal growth was 6.1%, it has been more of a statistical calculation that has caused real GDP from this part growing at 11.1%. With low consumption growth of 8.3% in Q2 relative to 13.4% last year, collections growth in nominal terms has been sluggish.
Seventh, the financial sector including real estate and professional services has been buoyant with 9.7% growth being witnessed. With professional services growing by 15.6%, it is tempting to conclude that self-employed income generation has been vibrant, probably reflecting growth in entrepreneurial spirit. The banking sector has been lacklustre in terms of business numbers, though value addition could be high because of higher spreads and profit margins being maintained, as the concept of value added looks at gross profit which is before provisions are made.
Eighth, the growth in GDP from public administration etc has been tardy, at just 4.7%. This is a let-down as it has always been maintained that the government should be the first to spend to kick-start the economy. Quite evidently, this has not yet happened, as the government has been cautious. The problem is really that once the government has to adhere to the 3.9% fiscal deficit number and nominal GDP grows at a slower rate, it would perforce have to trim its expenses, which can slow the growth process.
Ninth, the share of consumption in GDP has come down from 56.2% to 55.9%, which. though not really significant. is still indicative that consumption has not picked up. It may be pointed out here that the economy is confronting a situation where spending is low from all sectors. Household consumption was to be one of the areas of comfort, which has not picked up so far. However, again, Q3 and Q4 would be the critical phases for consumption.
Lastly, the gross fixed capital formation rate continues to lower—from 30.3% to 30.1% in real terms and 28.9% to 28.3% in nominal terms. This is a reflection of the construction sector which showed less traction. Hence, we are still waiting for investment to turn around.
How then can the GDP numbers be summarised? Numerically we are on the right path and stronger numbers may be expected partly due to negative deflators. Spending is still down, as all the main potential engines have been less active in the first half of the year. Interestingly, the share of valuables has gone up from 1.4% to 1.9% of GDP. While agriculture will be a concern going ahead, a lot is expected from the government in terms of spending, which can be challenged statistically by the lower nominal GDP growth number. Therefore, Q3 and Q4—and especially the former—will hold the clue from all points of action, i.e. consumption, investment and government spending.
The author is chief economist, CARE Ratings. Views are personal