Moneycontrol Pro Weekender | Q2 GDP growth falls off a cliff: pressure to cut rates increases

The shocking GDP print for Q2 puts in question the finance ministry’s full year’s growth estimate of 6.5-7 percent.

Dear Reader,

Nagesh Kumar, the only member of the Monetary Policy Committee (MPC) to have voted for a 25 basis point rate cut at its last meeting, has been proved right. He had pointed out that "Indian industry is clearly suffering from demand deficits in both domestic and external markets. Demand deficits may be the reason private investment has not picked up momentum despite the companies' healthy balance sheets and all the reforms and incentives extended by the government." The Q2 GDP growth of 5.4 percent bears out that truth. The State of the Economy report by RBI researchers, published a few days ago, estimated Q2 growth at a much stronger 6.7 percent. The MPC had pegged it even higher, at 7 percent. And while everybody agreed that growth would slow, the consensus was that it would drop to around 6.5 percent. The 5.4 percent growth number is a shocker.

Will the slowing growth lead to a rate cut at the MPC’s meeting next week? The RBI as well as the government has argued that the slowdown in Q2 was temporary, due to an extended monsoon and an inauspicious astrological period that led to large purchases being deferred. Those factors certainly had an impact, but the far lower than expected growth strengthens the suspicion that the slowdown is on account of more than merely seasonal factors. Moreover, the shocking GDP print for Q2 puts in question the finance ministry’s full year’s growth estimate of 6.5-7 percent, to say nothing of the MPC’s 7.2 percent forecast. Note also that the RBI’s clampdown on unsecured credit has led to a slowdown in bank credit growth and the latest data show that non-food bank credit growth has slowed to 11.15 percent year-on-year in mid-November, while it was 13.6 percent in mid-August. That doesn’t augur well for an economic rebound.

The sticking point, as the RBI governor has been at pains to emphasise, is that retail inflation for October, at 6.2 percent, was well above the upper limit of the RBI’s inflation target. The State of the Economy report by RBI researchers said, ‘’What is worrying is that apart from the sharp surge in the momentum of food prices, core inflation has edged up. There are early signs of second order effects or spill overs of high primary food prices.’’ The Flash PMI for November also shows core inflation moving up. The State of the Economy report had warned, “Inflation is already biting into urban consumption demand and corporates’ earnings and capex. If allowed to run unchecked, it can undermine the prospects of the real economy, especially industry and exports.’’

It is in these unenviable circumstances of lower-than-expected growth and higher-than-expected inflation that the MPC will have to decide on its policy rate at its meeting next week.

As for the analysis of the Q2 GDP data, here’s a short Q&A on it:

What do the Q2 GDP numbers say about private consumption demand?

Growth in private final consumption expenditure (PFCE) fell from 7.5 percent in Q1 to 6 percent in Q2. Commentary from companies indicates that rural consumption has revived and that is supported by the growth of Gross Value Added (GVA) in agriculture and allied sectors, which has gone up from 2 percent in Q1 to 3.5 percent in Q2.

What do the Q2 data say about capex growth?

Growth in gross fixed capital formation (GFCF) fell from 7.5 percent in Q1 to 5.4 percent in Q2. What’s more the ‘’Discrepancies’’ figure in Q2 GDP is a negative 1.5 percent of GDP and it is possible that, once the final revisions are done, the negative figure could drag down either the consumption or capital formation share of GDP even further.

Are the sectors that generate jobs for the masses doing well?

The construction sector, the prime source of jobs for the masses, grew by a healthy 7.7 percent in Q2. While this is a comedown from Q1’s sizzling 10.5 percent growth, one reason for the lower growth is the base effect. The other major source of mass jobs, the “Trade, Hotels, Transport, Communications etc’’ sector, saw higher growth of 6 percent in Q2, against 5.7 percent in Q1, but that too is due to the base effect.

Is the share of manufacturing in GVA increasing?

Manufacturing growth in Q2 has been a mere 2.15 percent, compared to 7.1 percent in Q1. But there’s a big base effect at work here—growth in Q2 in manufacturing was a very high in the year ago period. In fact, the share of manufacturing in total GVA was higher at 17.3 percent in Q2 FY25, compared to 16.8 percent in Q1.

What about the road ahead? The view that the slowdown in growth in the Indian economy is not merely seasonal has gained support from the very weak Q2 GDP print. Moreover, global uncertainties are set to increase with the change in the US government. Higher tariffs, a push to Chinese imports, a stronger dollar and outflows from capital markets are all looming risks.

Against that view, on the positive side are ranged higher farm production and more government spending in the second half of the fiscal year. The risk here is that the flood of freebies being promised in recent state elections, while supporting mass consumption, is likely to affect capex by state governments.

Nomura, which believes the slowdown is cyclical, has said in a recent report, “Urban consumption indicators have been softening, and there is evidence that companies are scaling down their salary outlays. Tight monetary policy and the RBI’s macroprudential crackdown on frothy credit are being reflected in a slowing of personal loans and lending growth by shadow banks. Also, the government continues to struggle to revive spending after the general elections.”

The government seems to believe that RBI’s tight money policy and its macroprudential regulations are hurting growth. The finance ministry’s latest monthly Economic Review has said, “Bright agricultural production prospects make the inflation outlook benign, despite existing price pressures in select food items.” And, after all, the problem of high food prices is for the government to tackle—the RBI can do nothing to bring food price inflation down. Under these circumstances, there’s a strong case for the MPC to cut rates, while the government tackles high food prices.

The bigger concern is that expressed by Motilal Oswal economist Nikhil Gupta, who in a note titled ‘’Consumption Slowdown—Cyclical or Structural?’’ said, “we wonder about the sustainability of the current divergence within household spending, wherein the high-ticket branded premium segment (within consumption and investments/real estate) continues to outperform the mass low-ticket spending. If personal income growth does not pick up, it is very likely that the outperformance of the former will match the underperformance of the latter, pulling (down) the entire economic growth.’’

Cheers,
Manas Chakravarty

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