India's GDP growth is more realistic in Dec 09 quarter

India’s GDP grew 6% in 3QFY10, following strong growth of 7.9% in 2QFY10. The number was substantially lower than consensus’ estimates (6.8%). The major surprise came from social and personal services, which declined -2.2% in 3QFY10. If you look at he numbers more closely, you will find that this growth number (6%) is actually better than the previous quarter growth of 7.9%. You must be wondering that this guy has lost it completely. Well, I will just say let the numbers speak to you. Here is the table.

The growth rate of 6% in 3QFY10 seems to be more close to reality than last quarter’s growth rate, which was inflated by government consumption. In 3QFY10, government consumption declined 10.3%, following an increase of 26.9% in 2QFY10. Excluding government consumption, GDP (at constant market prices) grew impressively by 8.5%, as against 4.8% in 2QFY10. That is why I was saying that this quarter growth is better than that of the previous one.

Well this is not it. There are some more interesting points to come. Industry which has 28% weight in the overall GDP, witnessed a strong rebound in 3QFY10. It grew by 11.6%, way ahead of the 7.5% growth average recorded in the past decade. Manufacturing grew a whopping 14.3%, the highest growth in more than a decade.

On the down side, services, having a weight of 56% in the GDP, recorded a decade low growth of 6.3%, dragging down economic growth. Another problem for the economy is its low investment growth. Real investment grew at a tepid rate of 5.1% in 3QFY10. Investment growth continues to be sluggish with a meager 2.4% average growth in the last seven quarters. The investment cycle, however, seems to have bottomed out. Nevertheless, we do not expect a strong recovery in investment before FY12.

The Economic Survey FY10 estimates FY11 GDP growth at 8.2%, which seems quite optimistic. Until India witness a strong recovery in the investment cycle, which was the main driver of growth during FY04-FY08, returning to the 9% kind of growth levels seems unrealistic. Investment growth was around 18% during the FY04-08 period. Furthermore, fourth quarter GDP numbers from many developed economies indicate the fragility of the much-talked-about global recovery.

RBI takes on liquidity

In a rather hawkish move, the RBI increased the cash reserve ratio by 75 basis points to 5.75% in order to address the ongoing liquidity overhang in the system. Other policy rates were left unchanged. The move is expected to drain Rs 360 billion from the system. In the last one month, the overall liquidity in the market has been around Rs 600 to Rs. 800 billion. So factoring in RBI’s rate action, there will still be around Rs 300 billion to Rs 500 billion left in the system.

The comforting factor here is that central government is done with its massive market borrowing programme for the current fiscal. Nevertheless, the move is expected to raise short-term rates and will impact banks negatively. Banks would lose out on account of the increased CRR outgo. Given the current credit demand and deposit growth scenario, it would be difficult for banks to even partially pass-through the same through either a hike in lending or a cut in deposit rates.

As the wholesale price inflation surged to 7.3% in Dec ’09 and the consumer price inflation remains in the teens, the RBI is now focusing more on managing inflationary expectations. The RBI, however, has pointed out that the recovery is yet to fully take hold and that it would require sequenced withdrawal of exit from the current extremely accommodative regime.

To sum up, the recent aggressive tightening in the CRR indicates that the RBI will not take any rate action until the next policy review on 20 April 2010.