India Q2FY23 GDP: Looking beyond the noise

The Q2FY23 GDP numbers are unlikely to change the policy focus of RBI from withdrawing accommodation, with growth being in line with expectations

The pandemic, which was once in a lifetime shock, has made even relatively stable datasets such as GDP difficult to analyse. If one were to depend solely on year-on-year (YoY) growth rates, it would appear growth slowed to 6.3 per cent in Q2FY23 from 13.5 per cent in Q1FY23. However, the slowdown is partly a play of base effects, which have distorted the YoY growth momentum. To overcome the distortion, we look at a three-year compound annual growth rate (CAGR), which will compare recovery with the pre-pandemic period, or Q2FY23 over Q2FY20. On this metric GDP growth improved to 2.5 per cent in Q2FY23 as against 1.3 per cent in Q1FY23. This was despite tighter financial conditions, decline in company profitability and export growth slowdown. So, you may ask: How did growth improve in Q2? The answer lies in a combination of transmission lags, services growth recovery, and continued support from urban consumption.

The combination of rate hikes and tighter inter-bank liquidity conditions has resulted in weighted average call rates rising by 240 basis points in FY23. However, transmission of policy rates hikes takes time with interest rates on outstanding rupee loans rising by 60 basis points in FY23 (April to October). Hence the impact of the rate-hiking cycle on growth is yet to be felt.

Sector-wise, manufacturing GVA was weaker than expected, reflecting lower company profits. However, the performance of listed companies indicates that this was driven more by higher input-cost pressures than a slowdown in sales. Looking ahead, we could see manufacturing sector performance remaining on the softer side, despite reduction in input cost pressures. This is because the sector tends to be closely linked with export growth, which has been slowing over the last few months as global demand conditions weaken.

Meanwhile, growth momentum in the services sector picked up but the scars of the pandemic are still visible in contact-intensive sector – trade, hotel and transportation. This sector was impacted the most by the pandemic and has been the slowest to recover. In Q2, growth has just about inched back to pre-pandemic levels with the three-year CAGR at 0.7 per cent against a 5.5 per cent decline in Q1. More than 60 per cent of this sector is trade, which has picked up as indicated by rise in individual movement and GST e-way bills. Hospitality, which has a 6 per cent share (pre-Covid-19) in trade hotels and transportation, has witnessed a strong pick-up as consumption patterns normalise. Growth in real estate and financial services was higher by 2.5 per cent (three-year CAGR) in Q2. Around 70 per cent of this sector is real estate, where growth has held up despite a stronger transmission of interest-rate hikes. Indeed, mortgage loans growth has remained strong at 16.2 per cent YoY as of October 2022.

Private consumption, which has been the main engine of the recovery, continues to gain momentum growing by 3.6 per cent (three-year CAGR). This likely reflects strong growth in urban consumption, which is indicated by a pick-up in passenger vehicle sales, higher non-oil non-gold imports, surge in government tax revenues, etc. Urban wages growth has outpaced inflation, supporting demand. The rural side of the recovery has been more gradual with wage growth averaging at 4.8 per cent in April-September, which is lower than the average level of inflation. That said, agriculture GVA (gross value added) was much stronger than expected in Q2, despite the first advance estimate for kharif foodgrain production being lower by 3.9 per cent. The strong performance could reflect activities such as livestock and logging, which accounts for roughly half of the agriculture GVA. Looking ahead, consumption expenditure is likely to hold up in the remainder of FY23, despite tighter financial conditions as household debt levels remain moderate. Indeed, as of Q4FY22, the household debt-GDP ratio moderated to 35 per cent from the pandemic peak of 39.3 per cent in FY21 Q4.

The capex cycle recovery, which is being observed with bated breath, has continued with investment-GDP ratio holding at 35 per cent in Q2FY23 versus pre-pandemic levels of 31 per cent in Q2FY20. The Central government has played a key supportive role by front-loading capital expenditure, currently tracking higher by 61.5 per cent YoY in April-October. In contrast, state government capex has been on the softer side with expenditure growth of 7.7 per cent YoY in H1FY23, based on the fiscal accounts of 19 state governments. Conditions are supportive of private sector capex recovery with balance sheets of both banks and companies in much better shape. However, the uncertain global outlook could delay the recovery with weakness in exports. Indeed, the drag on growth from net imports remains in Q2FY23, reflecting a combination of weaker exports and elevated imports.

The Q2FY23 GDP numbers are unlikely to change the policy focus of the Reserve Bank of India (RBI) from withdrawing accommodation, with growth being in line with expectations. Inflation followed by global monetary policy will remain the key determinant. Both these factors support continued front-loading of rate hikes, with the consumer price index expected to stay above the RBI’s upper threshold of 6 per cent till Q4FY23 and the US Fed unlikely to end its fight against inflation.

The author is an Economist at IDFC First Bank