Reconciling Consumption And Capex Drivers To Un-layer Q3 GDP Growth Outperformance

Compare this print to the International Monetary Fund’s end-January forecast of India’s FY24 growth of 6.5 per cent. Even more remarkable, this growth is in a global environment where the world economy is estimated to have grown at 3.1 per cent in 2023, with the developed economies growing at a meagre 1.6 per cent, and developing Asia at 5.4 per cent, largely on account of India and China.

There were also many revisions in data pertaining to past quarters and financial years. A standout was the revision in the GDP growth number for FY21-22, from the earlier 9.1 per cent to 9.8 per cent, which led to a slight drop in the revised FY22-23 growth from 7.2 per cent to 7.0 per cent. The latter, in turn, might have moderately boosted the FY23-24 growth number, in what analysts would describe as a low-base effect.

However, the underlying details of this outperformance need to be understood, especially the growth drivers that might be expected to sustain India’s FY24-25 growth at 7 per cent, as projected by the Reserve Bank of India.

GDP-GVA Conundrum

To begin with, the gap between GDP and Gross Value Added (GVA) growth hit a record (except for the early pandemic quarters) high of 1.9 percentage points in the October-December quarter (Q3). Formally, GDP is equal to GVA plus indirect taxes net of subsidies. GVA is considered a better measure of underlying economic activities and “aggregate demand”.

GVA growth in Q3 was relatively modest at 6.5 per cent. The reason for much higher GDP growth is the significantly higher indirect tax revenue on account of robust GST collections. Full-year GVA growth for FY 23-24 is estimated at 6.9 per cent, as against 7.6 per cent growth in GDP. This difference is likely to narrow in FY24-25.

Consider the output side of economic activities, using the annual growth prints. Keep in mind, in interpreting FY23-24 numbers, the effect of a strong “base effect” of growth in FY22-23, both negative and positive. Three sectors have been in the spotlight – agriculture, manufacturing and construction. The latter two are important sources for creating jobs.

The broader farm sector growth, estimated at a low of 0.7 per cent for FY 23-24, is largely disappointing. In FY22-23, it was 4.7 per cent and through the past decade, growth of the farm sector averaged at an annual 3.5 per cent. For the current fiscal year, the government estimates crop output to be 6 per cent lower than the previous year, which means it expects a good part of this contraction to be offset by higher output in horticulture, animal husbandry and ancillary activities.

As for the manufacturing sector, it is now larger than agriculture, and via anecdotal evidence, is now a growth powerhouse. Even factoring in a low-base effect, an 8.5 per cent growth in the current fiscal is robust. A word of caution, though: Part of the high real growth is the optics of negative manufacturing inflation. Indeed, nominal manufacturing growth in FY23-24 is estimated to be 6.7 per cent, implying that manufacturing prices are expected to register negative inflation, of about 1.8 per cent. This is likely to reverse significantly next year, thus reducing manufacturing growth in FY 24-25.

On the broader FY24 GVA, as a manifestation of the low deflator, one striking aspect is the narrowing of the gap between real and nominal growth – 6.9 per cent vs 8.2 per cent. That implies a gap of 1.3 percentage points, much narrower than 7.3 percentage points in FY22-23. This means that a likely significantly higher WPI inflation in FY24-25 will lead to a growth compression, although this might be somewhat offset by a lower forecast for CPI inflation.

The construction sector, which has a share of 8 per cent of GDP, is projected to grow at a robust 10.7 per cent pace in the current year, compared to 9.4 per cent in FY22-23. A large part of this is due to the central and state government’s emphasis on capital expenditure, particularly on roads, railways and defence.

Lastly, growth in the services sectors was mostly on expected lines. Growth in the Public Administration (7.7 per cent) seems robust. We presume that the “Other Services” component in this group is expected to perform well. This segment comprises services provided mostly by smaller firms in the multiple repair and professional services used by households and micro and small enterprises.

Concerns Over Exports, Consumption Demand

The demand of the GDP data is of greater salience since this more closely shapes policy choices, particularly monetary policy. Here, too, there are some notable points.

First, on the external front, the trade deficit in goods and services (exports minus imports) is estimated to increase sharply in FY23-24, with the trade gap widening to Rs 4.4 lakh crores from Rs 71,000 crore in the previous year. Being a negative entry in the GDP equation, this is a significant brake on growth, and hopefully, will improve in FY24-25 as global trade picks up and crude oil prices moderate.

Secondly, as expected and as indicated by the growth in the construction sector, investments or capital spending rose 10 per cent year-on-year. But this is largely driven by public sector spending, particularly by the central government and central public sector undertakings.

However, as the government’s own Economic Review that was published ahead of the Interim Budget indicated, even private sector capex had increased significantly in the first half of FY23-24 and is likely to further accelerate next year. Results of an RBI survey showed capacity utilisation increasing by 40 basis points to 74 per cent in Q2 of FY23-24. The long-term average over the past 15 years (excluding the locked-down quarter of 2020) is 73.7 per cent.

Third, and the main point of concern, remains a tepid growth in private consumption, which increased at 3 per cent year on year. To an extent, this is due to the base effect of the robust 6.8 per cent growth in FY22-23, but still indicates subdued consumption demand (to which is added the relatively soft growth in government revenue spending).

This low growth, moreover, has persisted since the third quarter of FY22-23. The FY22-23 growth in private demand is consistent with the results of the 2022-23 household consumer survey, which showed improving consumption across income classes. The stagnation, which is presumably more pronounced in rural areas and is consistent with the narrative of FMCG companies, will need to be reversed if India is to sustain a 7 per cent annual growth rate.

An encouraging sign here is that inventories continue to be accumulated, which suggests that manufacturers remain optimistic about future demand. Note that this softness is also somewhat inconsistent with the presumed growth in “other services” noted above, which captures the micro and small enterprises that are also a large pool of consumers.

What does all this mean for policy?

The estimated FY23-24 growth, seen together with RBI’s 7.0 per cent GDP growth forecast for next year, is likely to delay any rate cuts by the Monetary Policy Committee. Despite the concerns of some of the MPC members regarding the decelerative effects of high real interest rates on potential economic growth, there is the possibility of sustained economic activity once again stoking core inflation. Strong equities markets further risk reinforcing wealth effects. The RBI’s actions in future will, of course, also depend on the actions of global central banks.

Over a longer horizon, past and ongoing structural changes, institutional improvements and policy frameworks are increasingly strong enablers for India to grow sustainably at high rates. Growth needs to sustain at 6.5 per cent - 7 per cent annually over the next 10-15 years for India to reach the upper middle-income class of nations and pull out millions of families that still languishing in poverty.

(The author is former Chief Economist, Axis Bank. Views expressed are personal)