INDIA REACT: Growth without inflation suggests higher potential
The key takeaway - the pickup in growth, without demand-pull inflationary pressure in the economy, supports our thesis that reforms have lifted India's potential growth, and activity ahead is likely to remain non-inflationary, writes Abhishek Gupta.
A quicker-than-expected acceleration in India's GDP growth last quarter was supported by a favourable, low base in the year-earlier period. Green shoots were also visible in certain sectors. The key takeaway - the pickup in growth, without demand-pull inflationary pressure in the economy, supports our thesis that reforms have lifted India's potential growth, and activity ahead is likely to remain non-inflationary.
- GDP expanded 8.2% year on year in Q1 of fiscal 2019, up from 7.7% in Q4 of fiscal 2018. The result was 0.6 ppt above the consensus estimate of 7.6%, and 0.7 ppt higher than our estimate.
- Growth in gross value added -- a more meaningful measure that strips out net taxes -- came in at 8%, up from 7.6% in Q4. The reading was 0.5 ppt higher than consensus and 0.6 ppt higher than our forecast.
- The pickup in growth was largely driven by favourable base effects. The economy in the year-ago quarter was depressed due to an inventory draw-down ahead of a goods-and-services tax introduced in July last year. This was most evident in the manufacturing sector.
- A stronger recovery in the sub-group of financial, real estate, IT and businesses services -- despite highly adverse base effects -- points to green shoots of recovery.
Base Effects Plus Green Shoots of Recovery Driving Growth
In our view, India's potential growth is around 8-8.5%, above the consensus and Reserve Bank of India view of around 7-7.5%. Going ahead, we expect the output gap to remain negative and continue to pressure down core inflation. With inflation already starting to surprise on the downside, we expect the RBI to return to a long pause on rates.
History Suggests India's Potential Growth Likely Underestimated
Decomposition of Changes in RBI's Foreign Currency Assets
Looking ahead, quarterly GDP growth is expected to trend down as base effects turn adverse. Nevertheless, green shoots suggest that, adjusted for base effects, the recovery is likely to get stronger. This poses upside risks to our full year projection for GDP growth to recover to 7.2% in fiscal 2019 from 6.7% in fiscal 2018 -- 0.2 ppt below the central bank and consensus projection of 7.4%.
Our monthly tracker for the rural economy shows a strong recovery. We were expecting that the headwinds from higher oil prices, rising interest rates and a still-weak banking sector would pose risks to growth in the industrial sector and the urban areas. That might still be the case, but the latest growth numbers suggest that the structural reforms of the past few years are starting to support a broad-based growth recovery and are likely countering the headwinds.
Components of GDP Growth
- Agricultural growth increased to 5.3% in 1Q fiscal 2018 from 4.5% in 4Q fiscal 2018. This was driven by strong growth in food grains and commercial crops during the 2017-18 rabi season that ended in June. It was also supported by buoyant growth in the livestock, forestry and fisheries sectors.
- Manufacturing, the largest segment in the industrial sector, accelerated to 13.5% in Q1 from 9.1% in Q4. This was primarily driven by supportive base effects and was a key reason behind higher GDP growth.
- Construction-services growth dropped to 8.7% in Q4 from 11.5% in Q1. Rising mortgage rates likely contributed to the slowdown.
- Growth in the wholesale and retail trade, hotels, transport and communication sector marginally slowed to 6.7% in Q1 from 6.8% in Q4. The absence of sales tax data, which has been subsumed under GST, makes this estimate less reliable.
- Finance, real estate and IT services growth increased to 6.5% in Q1 from 5% in Q4, despite adverse base effects. This was likely driven by green shoots in IT and business services.
- Growth in public services slowed to 9.9% in Q1 from 13.3% in Q4. The key indicator of this sector, namely the central government's current expenditure adjusted for interest payments and subsidies, grew by 14.5% in Q1 relative to 19.8% in the year ago quarter.
India Forecast Table
Abhishek Gupta covers India for Bloomberg Economics in Mumbai. He previously worked as an economist at DSP Merrill Lynch and as a research analyst at the National Institute of Public Finance and Policy, India's premier macro/finance think tank.