Indian Economic Update
India: Growth shows a significant fillip; consumption on a recovery path
Gross Value Added (GVA) growth for Q4 FY2018 picked up to a seven-quarter high 7.6% YoY, surpassing our expectations of a 7.0% YoY print. GVA growth has been significantly propped up by government spending in Q4, excluding which, growth would have printed at 6.7% YoY. Gross Domestic Product (GDP) also clocked a higher than expected 7.7% YoY in Q4 (expected 7.2% YoY) supported by robust growth in government spending and investment. Barring two of the services components, all sectors of the economy accelerated in Q4 FY2018 on a sequential basis.
The GVA growth numbers for the previous two quarters of FY2018 were revised slightly lower (from 6.2% to 6.1% YoY in Q2 and from 6.7% to 6.6% YoY in Q3). The GDP growth numbers were revised lower by 10-20 basis points (bps) for Q1, Q2 and Q3 of FY2018.
On an annual basis, GDP growth has been revised slightly upward to 6.7% YoY from 6.6% YoY, while GVA growth has also been pegged slightly higher at 6.5% YoY. These are in line with our estimates for FY2018 (6.6% YoY for GDP and 6.4% YoY for GVA).
Key highlights of Q4 FY2018 GDP:
- In a slightly unwelcome development, core GVA growth (non-agriculture non-government spending growth) has fallen to 7.2% YoY in Q4 FY2018 from 7.4% YoY in the previous quarter, given the slowdown in other components of the services sector.
- Agriculture growth clocked a four-quarter high of 4.5% YoY, rising from 3.0% YoY in 9M for FY2018. As we had expected, the third advance estimates of crop production showed that output of the rabi season had been healthy for most crops. The significant shortfall in wheat production, which was seen till late in the sowing cycle, was also alleviated, with production at 101% of target. Despite lower kharif production this year (2017 crop season), growth in agricultural value addition has been supported by healthy growth in non-crop sectors of forestry and fishing.
- On the industrial growth front, construction showed the largest sequential fillip, with growth at 11.5% YoY. This was along expected lines from the lead indicator, i.e., strong growth in infrastructure and construction goods in Index of Industrial Production (IIP) — 9.5% YoY in Q4 — though this also benefitted from a favourable base effect (-3.9% YoY in Q4 FY2017). This segment is also probably aided by the Government’s push for affordable housing and creation of infrastructure, and will continue to do well over the current fiscal. Manufacturing continued to outperform, as manufacturing Purchasing Managers Index (PMI) remained healthy in Q4, with stronger factory production levels translating into robust employment creation, and as corporate earnings growth in Q4 FY2018 was better than expected. However, even though there seems to be a manufacturing recovery, there is no such discernible recovery in exports growth, which still remains muted (3.6% YoY in Q4 FY2018).
- Of the three services sectors, growth slowed sequentially for two sectors in Q4 FY2018 (trade, hotels, transport and communication and financial, real estate and professional services). While financial, real estate and professional services could have been affected by an overhang of regulatory measures and subdued sentiment in the real estate sector, some fallout of Goods and Services Tax (GST) issues could have detracted from growth in the trade, hotels, transport and communication segment, since this sector has a substantial degree of informality. This number may anyhow be subject to revision, given statistical measurement issues in the GST regime. The robust Government spending growth in Q4 FY2018 (13.3% YoY) propped up services sector growth, without which GVA growth would have clocked a sharply lower 6.7% YoY. This was a slightly surprising development, given the fiscal concerns of the Government in the March quarter.
- Gross fixed capital formation grew by a significant 14.4% YoY, which was a welcome upside surprise, presumably aided largely by substantial Government spending amid its push for infrastructure creation. However, the Q3 FY2018 growth for Gross Fixed Capital Formation (GFCF) was revised downward to 9.1% YoY from 12% YoY. As these numbers are largely robust, private capex is being supported by improvement in Small and Medium Enterprise (SME) sectors. Ongoing corporate deleveraging in different sectors of the economy will progressively ensure that private capex complements Government spending in the coming quarters.
- Private consumption gained some traction, with growth at 6.7% YoY in Q4, alleviating our worries after the low print for Q3 FY2018. Given the Government’s focus on alleviating stress in the rural sectors of the economy, we feel a further fillip to consumption will be visible in the upcoming quarters. In this context, the trajectory of rural wages, Minimum Support Price (MSP) hikes and the spatial and temporal pattern of the monsoons will bear watching.
We peg our indicative FY2019 GDP growth forecast at 7.5% YoY and GVA growth at 7.4% YoY. Growth will be supported by fading of GST-related disruptions, renewed build-up of supply chains, improved rural consumption demand on the back of rising rural wages, shored up fiscal support and better export performance. Key risks to our outlook include oil prices retaining their bullish trend, impacting foreign inflows and inflation, or if the spatial/ temporal distribution of monsoons is unfavourable. In the absence of these headwinds, growth is expected to step up further.
Other important developments during the week were
- MSP recommendations for cotton and groundnut have turned out to be marginally more inflationary than expected by markets.
- As per Newswire sources, a finance ministry official said that the government favours a detailed policy regarding the Reserve Bank of India (RBI) dividend transfers and, if approved, this policy will be made a part of the RBI Act.
- Fiscal deficit for FY2018 printed at 3.53% of the GDP, broadly in line with the Government's revised estimates.
Important developments during the week
- Saudi Arabia and Russia have announced a new policy to revive oil production. The two countries agreed to restore some of the output they halted as part of an accord with 22 other producers, drawn from the Organisation of the Petroleum Exporting Countries (OPEC) and beyond. After Saudi Arabia said that petroleum supply would probably rise in the second half of the year, oil extended its biggest drop in almost a year. Brent crude has dipped over by 6% since Thursday, May 24, 2018.
- US President Mr Donald Trump said his summit with North Korea’s leader Mr Kim Jong-un could still happen on June 12 after officials on both sides started talking, a day after he cancelled it. South Korean President Mr Moon Jae-in held a two-hour meeting on Saturday with Kim on the border in a bid to keep the Trump summit on track.
- The US administration announced it will impose 25% tariff on steel imports and 10% on aluminium imports from Canada, Mexico and the European Union. In retaliation, Mexico said it would impose its own tariffs on apples, pork bellies and flat steel imported from the northern neighbour. The EU also threatened to impose its own retaliatory tariffs on US products such as motorcycles, jeans and bourbon. This led to concerns over a brewing trade war, which weighed on equities across the globe.
- Italy’s Prime Minister-designate Mr Giuseppe Conte named his Cabinet on Thursday, with the chiefs of anti-establishment parties Five Star Movement and The League backing his coalition Government in key ministerial roles.
Indian equities started the week higher. Benchmark indices gained following a decline in oil prices and easing geopolitical tensions. Equities declined on Tuesday, snapping a three-day winning streak dragged by banking stocks as losses widened in the fourth quarter for Public Sector Undertaking (PSU) banks on the bank of higher bad loan provisions.
Equities came under pressure following losses in global stock markets as Italy’s political crisis rippled across financial markets. Moreover, fresh fears of a trade war between US and China also weighed.
Benchmark indices gained towards the end of the week, supported by expectations that GDP growth likely expanded in the fourth quarter of 2018 by a faster than expected pace.
During the week Sensex gained 0.87% to close at 35227.26 and Nifty advanced 0.85% to close at 10696.20.
Government bond prices gained during the beginning of the week because of sharp fall in crude oil prices, coupled with improved market sentiment. However, some caution ahead of RBI’s monetary policy statement on June 6, 2018 prompted some traders to book profits.
However, bonds came under pressure as weakness in Rupee versus Dollar prompted heightened fear of Foreign Portfolio Investment (FPI) outflows. Lack of RBI Open Market Operations (OMO) purchase announcement weighed on the sentiment. Rise in crude oil prices strengthened fear of higher inflation and RBI rate hike on June 6, 2018. Rise in US yields also disrupted appetite.
The 10Y benchmark yield ended at 7.86% as against previous week’s close of 7.79%.
Oil — wait and watch!
- Crude prices recently plummeted, following Saudi Arabia and Russia’s intent to increase supply and are trading near our short-term view of USD 75 per barrel.
- Geopolitical developments continue to dominate the scenario, with the OPEC meet in June, Venezuela crisis and Iran sanctions posing as upside risks. We expect prices to average USD 71 per barrel for 2018.
Oil managed to increase by more than 10% and broke fresh highs since end 2014, crossing the USD 80 per barrel threshold. Recently, the two oil majors Saudi Arabia and Russia, expressed their intent to increase supply, to offset the output shortfalls from Iran and Venezuela, which took markets by a frenzy. Brent crude fell by 3% the following day and has continued to fall to more than 6% currently, from its peak of this year that was hit last week. Although this has partially offset the risk premium that was driving prices, there is considerable uncertainty ahead for prices to settle at these levels.
While we had predicted oil price (brent) to rise up to USD 75 per barrel in the near term amid geopolitical risks and supply pressures, these limits were far exceeded recently. A culmination of upside risks we had flagged, and unexpected supply disruptions, made the advent of these price levels possible. Trump pulled the US out of the international agreement and enforced the most severe sanctions on Iran, which was our worst-case scenario. New developments in the last month involving Venezuela, have made the crisis even more dire with the output floor shifting far below what we had imagined. Pipeline constraints in the Permian region, which was posed as a risk to the US supply growth in the medium term, manifested earlier than expected, hindering the US shale’s ability to respond to higher prices appropriately. Lastly, supply disruptions due to security concerns and vandalism of pipelines in Nigeria and bad weather conditions in Libya saw a combined outage of more than 250,000 barrels per day spread over this period.
Gold started lower this week. The metal was under pressure despite a weaker Dollar as revived hopes of the US-North Korea summit saw investors dump the risk haven commodity.
Meanwhile, the yellow metal was lifted as a deepening political crisis in Italy provoked a second day of heavy selling on European financial markets, though a buoyant Dollar kept the precious metal’s gains in check.
The yellow metal remained depressed despite a weakening Dollar as a sell-off in bonds post the unwinding of risk sentiment saw yields surge by more than 3.6%. The overreaction from the political turmoil in Europe slightly corrected and weighed on the safe haven commodity. Gold remained buoyant as the Dollar rally eased towards the end of the week, though the upside momentum was capped by an easing of political tensions in Italy. Escalating trade tensions between US and China were also seen supporting the safe haven metal.
The Rupee started this week on a stronger note against the USD as Dollar sales by exporters supported the Rupee. However, oil importers’ Dollar buys, coupled with sharp rise in Dollar index and Dollar demand likely for defence-related payments limited gains for the Rupee.
Meanwhile, foreign banks’ constant Dollar buys and importers’ Dollar buys weighed on the currency. Dollar sales by some foreign banks, noting weak dollar index, supported the currency towards the end of the week.
Source: ICICI Bank Research and Bloomberg.