Q3 GDP numbers flatter the markets on the upside…

The Q3 GDP numbers announced by the Central Statistical Organization (CSO) on Feb 28th was surely a pleasant surprise. The general belief was that the demonetization exercise would have dented the edge of growth. In fact, some economists had even predicted Q3 GDP growth as low as 5.8%. It, therefore, came as a big surprise when the Q3 GDP came in at 7% and the full year projection came in at 7.1%. Here are the key takeaways from the GDP announcement for the third quarter as well as the second revised estimates of GDP for the full year.

Key Takeaways from the GDP announcement by the CSO…

  • The most optimistic estimates for Q3 GDP were placed at around 6.5% while the most pessimistic estimates went as low as 5.5%. The Q3 GDP at 7% is gratifying principally because many of the customer facing sectors like automobiles, two-wheelers, FMCG, consumer finance and consumer durables had all faced weak demand and dwindling footfalls. It is in this light that the GDP for Q3 at 7% becomes all the more relevant. What it indicates is that the apprehensions around demonetization were largely exaggerated.
  • The previous estimates for full year GDP that was put out in December did not consider the impact of demonetization. What the revised data reveals is two positive hints. Firstly, the actual impact of demonetization on growth has not been too much as aggressive government spending and a revival in agriculture compensated for the demonetization impact. Secondly, the remonetization that started from January is likely to have a salutary impact on GDP and the fourth quarter GDP growth could go as high as 7.4-7.5%.
  • Within the GDP constituents, it was agriculture that was a major positive surprise. For the full year 2016-17, agriculture is likely to grow at 4.4% compared to a mere 0.8% in the previous fiscal. Of course, the credit largely goes to normal monsoons after 2 successive years of drought. However, it must be said that the government has addressed the issue of supply-side bottlenecks quite effectively which is evident from the low levels of food inflation. There was some disappointment in the Rabi sowing due to disappointment but that was more than compensated by the estimated 10% improvement in the production of food grains for the full year.
  • The manufacturing space continues to be a drag on the overall GDP. For the full year, the manufacturing growth is likely to be lower by nearly 300 basis points compared to the previous year. But there is a major divergence within the manufacturing space. While the large cap organised manufacturing has managed to grow quite satisfactorily, it is the SME manufacturing that has registered negative growth of -0.5%. This segment is critical because of the huge externalities that it has on the employment and job creation in the economy. The big takeaway here is that when the revival happens, it can happen without additional investment as the manufacturing sector is already operating at less than 70% capacity utilization.
  • The services sector presents a starkly contrasting picture. Typically, services that are driven by government spending have done extremely well. It needs to be remembered that services account for over 60% of the GDP followed by manufacturing and agriculture. Also the services sector is extremely quick to transmit wealth effects and inflation across the economy. Public services like gas supply and electricity have growth smartly as these are largely driven by government spending. Similarly, services like public administration and defence have shown very strong growth during the year. Effectively, wherever there is government drive involved, those particular services have done extremely well.
  • However, within the services space, many private sector driven services have disappointed in the year. For example, construction is likely to remain flat. This sector is crucial to the economy due to its strong multiplier impact on the economy. Similarly key services that are driven by private consumptions like trade, hotels, insurance, professional services etc reported lower growth compared to last year.
  • That brings us to the critical question; what does this augur for the RBI rate stance. To be fair to the RBI, the stance has already been shifted from accommodative to neutral. That leaves the door open on both sides for the Monetary Policy Committee (MPC) to tweak rates. But how will GDP estimates impact the RBI rate stance. When the MPC cut rates in October by 25 basis points the idea was to give a thrust to growth. However, two things have now become evident. Firstly, the demonetization has resulted in better transmission and substantially lower cost of credit in the economy. Secondly, the impact of demonetization has not been so negative and hence the RBI will not have to cut rates purely to spur growth. Its focus will be more o non-food inflation and the rate stance of the US Fed.

In short, the Q3 GDP has come as a pleasant surprise for the markets. To an extent, it will dissipate the worries over demonetization. How well the economy bounces back in the fourth quarter and in subsequent quarters will be the acid test for Indian GDP growth!

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