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GDP surprise: India grows at 8.88%
December 3, 2010

India GDP Update

Author : Manjunath Gaddi

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Key Points

  • The GDP growth for second quarter (July – September)  of Financial Year (FY) 2010-11 is at 8.89%
  • The GDP growth for the first half (April – September) of FY2010-11 is at 8.88%
  • Good monsoons have helped the agriculture sub sector to grow by a healthy 4.40%
  • Growth in the manufacturing sub sector moderating

Many economists are surprised with the India’s GDP growth at 8.90%, Year on Year (Y-o-Y) basis for second quarter of FY2010-11, since it was expected that GDP would grow by 8.20% according to Bloomberg survey.

The equity market has cheered the positive upside and SENSEX closed 116.15 points higher on 30 November 2010.

As seen in table 1, all the eight economic sub-sectors have registered positive Y-o-Y growth. The electricity sub-sector has registered the lowest Y-o-Y growth rate at 3.40% while the Trade, Hotels, Transport and Communication sub-sector grew the fastest of all the eight sub sectors at 12.10%.

Table 1: Y–o-Y growth in the eight sectors that constitute the GDP
Q2 2010-11 Q1 2010-11 Q4 2009-10 Q3 2009-10 Q2 2009-10 Q1 2009-10 Q4 2008-09 Q3 2008-09 Q2 2008-09 Q1 2008-09
GDP -  Total 8.9% 8.9% 8.6% 6.5% 8.6% 6.0% 5.8% 6.1% 7.5% 7.8%
Agriculture, Forestry and Fishing 4.4% 2.5% 0.7% -1.8% 0.9% 1.9% 3.3% -1.4% 2.4% 3.2%
Mining and Quarrying 8.0% 8.4% 14.0% 9.6% 10.1% 8.2% -0.3% 2.7% 1.6% 2.6%
Manufacturing 9.8% 13.0% 16.3% 13.8% 9.1% 3.8% 0.6% 1.3% 5.5% 5.9%
Electricity, Gas and Water supply 3.4% 6.2% 7.1% 4.7% 7.7% 6.6% 4.1% 4.0% 4.3% 3.3%
Construction 8.8% 10.3% 8.7% 8.1% 4.7% 4.6% 5.7% 1.1% 7.2% 9.8%
Trade, Hotels,  Transport and Communication 12.1% 10.9% 12.4% 10.2% 8.5% 5.5% 5.7% 4.4% 10.0% 10.8%
Financing, Insurance, Real estate & Business services 8.3% 7.9% 7.9% 7.9% 11.5% 11.8% 12.3% 10.2% 8.5% 9.1%
Community, Social & Personal services 7.3% 7.9% 1.6% 0.8% 14.0% 7.6% 8.8% 28.7% 10.4% 8.7%
Source: iFAST Compilations, Bloomberg

 In comparison to the first quarter of the current financial year, Agriculture, Construction, Financial Services and Social services sub sectors have seen higher growth in the second quarter while, for  the other sub-sectors, the growth has reduced, most notably that of the manufacturing sector. Also,  compared to the second quarter of FY2009-10, Agriculture, Construction, Trade, hotels sub sectors has seen a huge growth, where as manufacturing sub sector has managed to grow slightly. The financial services, electricity and social services sub-sectors have seen reduction in their growth rates in comparison to growth rate seen in the second quarter last financial year.

GDP growth in second half leads

The Central Statistical Organization (CSO) has revised the first quarter 2010-11 (April – June) GDP growth upwards to 8.88% from 8.80%, there by leading the first half of FY2010-11 GDP to 8.88%. As seen in chart 1, the economic activity in third and fourth quarters is much higher than the economic activity in first and second quarters. With GDP growth already close to 9% and higher economic growth in third and fourth quarters, we can expect the GDP growth for FY2010-11 to exceed 9%.

Key Concerns

The Wholesale Price Index (WPI) inflation for October is at 8.58%, much higher than the central bank’s March 2010 target level of 5.50%. Although the current level of inflation is still above the comfort zone of the RBI, the central bank has observed that WPI inflation and the non-food manufacturing inflation have moderated in the recent months. However, the food inflation has not moderated as expected despite good monsoon.

With better-than-estimated economic growth, the RBI may resort to continuation of a tight monetary policy if the WPI inflation does not moderate as expected towards 5.50% levels by March 2011. As the monetary tightening takes time to affect the economy, the earlier rate hikes by RBI would hamper the growth prospects of the next financial year and further more hikes would subsequently impact economic growth.

Chart 1: Level of ECONOMIC ACTIVITY over various quarters

Outlook on Rupee

Traditionally, much of the economic growth for India is due to the domestic consumption. The rapid recovery in the Indian economy post the credit crisis and the slow growth in the developed world has led to balance tilting to a situation wherein we are having a higher current account deficit. As of first quarter of FY2010-11, the Current Account Deficit (CAD) stands at US$ 13.7 billion, the highest ever.

Generally, the Rupee should have depreciated on account of higher CAD; on the contrary, the Rupee has been appreciating for most part of this year due to the huge foreign inflows into Indian equity and debt markets. The Rupee would face huge depreciation if any global economic event forces the foreign flows to reverse. Also, the CAD is expected to continue at higher levels because India needs to import oil, coal and other infrastructure materials to power its high economic growth trajectory. The higher level of imports will certainly put pressure on the Indian Rupee in the medium to long-term unless, exports increase at a very rapid phase.

Impact on Debt Markets

The liquidity in the system continues to be in deficit mode. The liquidity deficit in the system has been persistent since the closure of the 3G auctions. Also, the Initial Public Offerings (IPOs) and Follow on Public Offering (FPOs) of government owned companies have put pressure on the liquidity situation as many investors are borrowing for the short term to invest in these IPOs and FPOs for listing gains.

The RBI has announced liquidity easing measures on 29 November 2010 to maintain the liquidity  at a reasonable level. However, both the surprise in GDP growth and liquidity easing measures failed to lower yields in the G-Sec market. The 10 year G – Sec bond yields continue to hover above 8% as the debt market is still unsure whether RBI has paused its tight monetary policy for the next six months.

Impact on Equity Markets

The equity market has reacted favorably to the high GDP growth data. The equity markets are overvalued as the SENSEX is currently trading at 1 year forward PE at 20.12X as at 1 December 2010, while the long term fair PE value for SENSEX is 17X . The Indian equity market may be range bound with uncertainty in global economies and markets with the third quarter results acting as triggers for breaking the range.

As at 1 December 2010, the consensus estimates of earnings growth for FY2010-11, FY2011-12 and FY2012-13 have been revised to 15.54%, 20.76% and 18.83% with 1 year, 2 year and 3 year forward PEs at 20.12X, 16.66X and 13.02X respectively.


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