Q4 GDP: Robust growth to keep rate cuts at bay

The weakness in global growth conditions are expected to intensify as the central banks' war against inflation is not over yet

The Q4FY23 GDP print at 6.1 percent was a good 100bps above our and consensus expectation. However more than the headline growth number, it’s the internals which are even more positive. The growth recovery was supported by multiple cylinders – services, construction, manufacturing and agriculture. More than half of the growth was supported by the services sector, in particular private sector services. ‘Trade, hotels and transportation’ which had been impacted maximum by Covid-19 related restrictions, is now 11 percent above pre-Covid-19 levels (Q4FY23 v/s Q4FY20). This translates into 3.5 percent growth on a CAGR basis. The improvement in the sector has been supported by urban consumption reflecting a strong comeback in tourism and consumption patterns normalising from goods to contact-intensive services.

The pick-up in residential real estate is likely behind the strong growth that is being captured by the real estate services and construction sector. High-frequency indicators such as state government stamp duty collection and strong growth in steel consumption also support this. The improvement in residential real estate is key for sustained pick-up in the capex cycle as households account for 40 percent of investment (Gross Fixed Capital Formation). Government support has been pivotal for the capex cycle recovery with Central government capital expenditure rising by 23 percent in Q4FY23. State governments capital expenditure which had a slow start in FY23, also accelerated in Q4, rising by 25 percent year on year. The pick-up in investment is also supported by rising capacity utilisation levels in the manufacturing sector which are now above the long-run average.

Investment-led growth

As a result, for the last two quarters, investment growth has led growth recovery, resulting in the investment-to-GDP ratio rising to 35.3 percent in Q4FY23, which is the highest since mid-2011. An investment-led recovery tends to be more sustainable as it is associated with employment creation which in turn supports consumption. That said, the private sector consumption recovery has remained surprisingly underwhelming rising by just 2.8 percent in Q4. Given the strong performance in the services sector (excluding government services) as well as agriculture, private consumption was expected to be stronger. That said, high-frequency indicators did show a mixed trend in Q4 with a slowdown in passenger vehicle sales and muted growth in consumer goods production. Urban consumption which was the first to recover post the Covid-19 shock, continues to drive private-sector consumption. Rural consumption is showing nascent signs of recovery supported by a pick-up in rural wages.

The strong GDP print comes against a weak external background. Despite this external trade turned growth supportive, accounting for nearly 24 percent of overall GDP growth in Q4FY23. This reflects a combination of two different trends – a sharp reduction in trade deficit and a surge in services surplus. The reduction in trade deficit is a story of moderation in domestic demand which has supported faster reduction in merchandise imports, outpacing the reduction in exports. Meanwhile, the surge in service surplus reflects India’s advantage in software services exports as well as resilient growth conditions in the US.

Easing cost pressures

The weakness in global growth conditions are expected to intensify as the central banks' war against inflation is not over yet. Core inflation has proved increasingly sticky in advanced economies, reflecting exceptionally strong labour markets. The key distinction this time has been that global growth slowdown has coexisted with exceptionally strong labour markets. Hence the global central banks may need to remain higher for longer with inflation proving equally resilient. Going forward we do expect the global growth slowdown to impact growth conditions in India. It will express itself via rising drag from net imports as export growth slowdown spreads from merchandise to services. Manufacturing growth tends to be closely linked with exports and we could see some moderation. The improvement in manufacturing growth in Q4FY23 was due to a sharp reduction in cost pressures which more than compensated for a slowdown in sales growth. Hence, we continue to expect moderation in FY24 growth, but the slowdown is likely to remain moderate with domestic demand supported by multiple growth engines. We expect FY24 GDP growth at 6.2 percent versus 7.2 percent in FY23.

The resilient growth conditions provide monetary policy space to remain focused on containing inflation. We expect the RBI to remain on a prolonged pause till December 2023. With the rate hiking cycle behind us liquidity management will be key, and the focus will be on maintaining overnight rates near the repo rate. Liquidity conditions which had tightened with a sharp reduction in system liquidity are showing signs of easing as government expenditure picks up. Moreover, the withdrawal of Rs 2,000 notes is likely to provide a transient boost to liquidity by temporarily reducing currency leakage. Hence, the RBI is likely to retain its stance of withdrawal of accommodation in the June meeting.

Gaura Sengupta is India economist, IDFC FIRST Bank. Views are personal, and do not represent the stand of this publication.