GDP Growth Slump: This Could Have Been Much Worse

As portended by a number of lead indicators, particularly related to industry, trade, and agriculture, Indian economic growth slid further in Q2FY20.

In constant terms, the gross domestic product and gross value added growth slowed to 4.5 percent and 4.3 percent, respectively, in July-September, from 5.0 percent and 4.9 percent, respectively, in Q1FY20. The GDP growth in Q2FY20 stood at a 26-quarter low, whereas the GVA expansion in that quarter marks a series-low. Moreover, in nominal terms, GDP and GVA growth declined respectively, to 6.1 percent and 6.3 percent, in Q2FY20, both of which are a series-low.

The Data Fineprint

Growth of industrial GVA recorded a broad-based decline to 0.5 percent in Q2 from 2.7 percent in Q1. This was led by the 1.0 percent contraction in manufacturing GVA in Q2, which reflects the lacklustre volumes reported by several sectors. One of the worst affected was the automobile sector, which has undergone a sharp worsening in the year-on-year volume contraction in Q2.

In our view, benign raw material prices prevented manufacturing GVA from displaying an even deeper contraction in Q2.

Moreover, mining and quarrying, construction and electricity all displayed a slowdown in GVA growth in Q2FY20, which can partly be ascribed to the disruption caused by an above-normal monsoon, as well as a decline in household and agricultural demand for electricity following heavier-than-normal rains.

Agricultural growth rose marginally to 2.1 percent from 2.0 percent in the previous quarter. The first advance estimates of crop production have indicated a mixed trend in the output of kharif crops. However, we are apprehensive that the late withdrawal of the monsoon damaged standing crops, which could lead to yields being lower than the initial estimates.

As expected, service sector growth broadly maintained its growth momentum, in line with the previous quarter. However, its constituents displayed varied trends. Unsurprisingly, trade, hotels, transport, communication and services related to broadcasting, one of the major sub-sectors of services, recorded a sharp slowdown in growth to 4.8 percent in Q2FY20 from 7.1 percent in Q1. This was inevitable following the broad-based weakness displayed by several indicators of freight, including the contraction in air cargo traffic, railway revenue carrying freight, and diesel consumption.

The expansion in financial, real estate and professional services eased only marginally to 5.8 percent, from 5.9 percent in the previous quarter.

Saved By The Exchequer

However, with a surge in government spending in Q2FY20, public administration, defence, and other services (PADOS), emerged as the fastest growing sub-sector in that quarter, recording an 11.6 percent expansion.

Additionally, for the 24 state governments for which data is available, revenue expenditure growth increased sharply to 16.8 percent in Q2, after the completion of the Parliamentary elections, from a meagre 1.2 percent in Q1. Worryingly, excluding PADOS, GVA growth slowed to a subdued 3.2 percent in Q2 from 4.5 percent in Q1, which highlights the sluggishness in economic activity.

Have We Hit The Bottom?

So does this weakness in economic activity in Q2FY20 represent a trough? The picture revealed by the lead indicators for October 2019 is mixed at best. The late withdrawal of the monsoon and earlier onset of the festive season contributed to a weaker performance of some sectors, such as coal output and auto production, which also had a knock-on impact on various indicators of freight. Moreover, the heavy rains contributed to disruption in agricultural activities as well as construction in some parts of the country. The subdued trends in coal, electricity, and cement, in particular, drove a deep contraction in core sector output in October 2019. Moreover, the Government of India's expenditure growth decelerated in that month.

However, other sectors offer a more encouraging trend. For instance, non-oil merchandise exports, petrol and ATF consumption, and domestic airlines' passenger traffic recorded an improved YoY performance in October 2019 relative to the trend in the previous month. We are cautiously optimistic that some of these nascent trends may strengthen in the rest of the ongoing quarter.

At present, the extent of the recovery that we should anticipate in the economic growth momentum in H2FY20 remains hazy.

In our view, improvement in certain activities such as mining and construction after the lull in rains, a waning of the unfavourable base effect in some sectors such as automobiles, and a gradual improvement in sentiment, should lead to some pickup in GDP and GVA growth in H2FY20. Nevertheless, there are downside risks to our FY20 GVA and GDP growth projections of 5.6 percent and 5.8 percent, respectively. In particular, revenue considerations may necessitate expenditure cuts or deferral by the central and state governments toward the end of this fiscal year, which would dampen a major driver of economic growth.

Coming to the monetary policy outlook, the food price-led surge in the CPI inflation in October 2019 has contrasted with the weak GDP growth in Q2FY20. In October 2019, the MPC had indicated that it would retain the stance as accommodative for as long as necessary to revive growth. Based on this, there appears to be a high likelihood of another repo rate in the December 2019 policy review. The magnitude of this cut could be the standard 25 basis points, which would bring the total policy easing to 160 bps in 2019.

Aditi Nayar is Principal Economist at ICRA.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.