Overall government spend is projected to decelerate to 7.4% in H2, from 10.5% in H1, while an even sharper deceleration can be expected if the deficit target is to be met
Attempting forecasts (“nowcasts” as they are now called) of most economic variables for a contemporary year based on data available at best for 8 months out of 12 is anyway a fairly heroic and sanguine exercise. Applying this process to a system as complex as India’s, with sparse data capture, under-enumerated, is a fraught exercise. The process for the official projections should be understood prior to an attempt at interpreting the data. The first advance estimates (AE) for a fiscal year (FY) are released on January 7, followed by provisional estimates (PE) for the prior year (i.e. FY18) on the 31st of the same month and then the second AE on February 28. These estimates are based on extrapolations of the data relevant for individual sectors, available variably from April to October or November, but adjusted for H2 to H1 ratios of the previous few years. FY19 GDP growth is expected at 7.2%, and the underlying measure of economic activity, gross value added (GVA, which we think is the better measure of economic activity), is estimated at 7%. This was the market consensus, and our own forecast as well. For us, though, our internals were wrong; the actual manufacturing sector growth was lower than expected, but higher construction segment sector growth offset that, balancing each other out. Trends in the three main components of GDP growth—agriculture, industry and services—are shown in the attached graphic. While services have been the most consistent contributor to growth, industry, particularly manufacturing, seems to be reviving in FY19.
However, the more interesting narrative of the GDP estimate is from the demand side, which is an even more difficult exercise, as it comes with multiple assumptions. Three aspects are notable.
Firstly, the contribution of fixed investment (gross capital formation, or GCF) is estimated to rise significantly, contributing 4 percentage points of the total 7.2% in FY19 (vs 2.9 points of the total 6.7% in FY18). This contribution was 3.6 points of the 7.7% growth in H1FY19, implying that contribution is likely to be 4.4 points of the implied 6.7% in H2FY19 growth. GCF growth was 10.8% in H1. Which sectors might the high capex (GCF) spends be emanating from? Matching growth estimates from the output and demand projections suggest that this might be construction, electricity, and to an extent, manufacturing. That is an expectation of a strong and accelerating capex activity. A capex recovery in selected sectors was indeed becoming more visible (engineering, electrical equipment, pumps, motors, bearings, abrasives, etc), and was corroborated by the capital goods component of the Index of Industrial Production (IIP) data till October. However, the prospect of it accelerating in H2 is somewhat open to scepticism, particularly given concerns of a global slowdown (via weaker trade), little room for a fiscal stimulus given constrained capacity of governments to spend and rising interest rates increasing borrowing costs. Secondly, the growth of net exports (i.e. exports minus imports) is projected to be -2.2% in FY19, much better than the -6.8% in FY18. However, net export growth is projected to be 1.4% in H2FY19 vs -5.9% in H1. The bulk of this change is forecasted to be from lower import growth. Might part of this be emanating from expectations of lower crude prices? The rationale for this is not clear. One, these real growth numbers are deflated with the appropriate inflation indices. Two, with lower pump prices, consumption of petrol products might actually increase. Overall, higher net exports are adding 0.7points to the 7.2% growth forecast.
Thirdly, government consumption growth is also projected to slow down in H2 to 8.1% from 10.1% in H1, while overall government spends are projected to decelerate even more sharply to 7.4% in H2FY19 from 10.5% in H1. This is indeed likely to happen, with an additional concern being an even sharper deceleration than expected, if the Centre’s fiscal deficit is to be held at 3.3% of GDP.
Hence, based on the three factors above, there is a marked downside risk to the FY19 projections. There is yet another puzzle on the deflators, which are inflation measures that translate nominal (real + inflation) growths to real. Roughly, the (non-agriculture) GDP deflator is comprised of 40% WPI, 30% CPI and 30% volume indicators. The GDP deflators have tended to move more closely with the WPI inflation over the past couple of years, introducing a bias (admittedly small) in the real GDP growth. Although in FY19, this bias is downwards, and growth should actually be a few percentage points higher.
The nominal growth is projected to be 12.3% in FY19 (vs 10.1% in FY18), implying a GDP deflator of 4.8% in FY19 vs 3.1% in FY18. One implication is that this implies a higher FY19 nominal GDP level than the FY19 budget estimate (based on a 11.5% projected nominal growth) projected in February 2018. This will allow the Central government to spend a bit more—probably around Rs 4,000 crore—while adhering to the 3.3% fiscal deficit, but this is nowhere close to a stimulus which might now be needed.