India’s GDP growth in Q2 FY23 albeit healthy, decelerated sharply to 6.3% YoY from 13.5% in Q1 FY23. The downward slide in headline economic growth was broadly along expected lines (market consensus: 6.2%) due to the absence of favourable statistical base effect in Q2, in contrast to the significant boost it provided to Q1 data given the second Covid wave lockdown last year.

Sequentially, GDP expanded by 3.6% QoQ, better than the pre pandemic seasonal average (over a 10-year period) of 0.6% observed in Q2. This sequential expansion is in sync with the signal derived from other leading activity indicators, including our monthly Acuite Macroeconomic Performance Index (AMEP). The average value of the index which is based on sixteen high frequency indicators had grown by 12.7% in Q2FY23 as compared to Q2FY22.

Key highlights

Our observations will emphasize on the quarterly sequential momentum as YoY comparison will carry a significant statistical noise. Detailed YoY data is provided in the table below for comparison.

• Private consumption expanded by 1.0% QoQ, better than the pre pandemic seasonal average (over a 10-year period) of -0.8% observed in Q2. This appears to have been led by urban consumption (reflected in PV sales, air travel, credit card spend, etc.). Rural consumption recovery has been subdued in comparison on account of high farm input inflation, weak wage growth, and erratic rainfall, to name a few.
• Government consumption contracted by 18.9% QoQ, in contrast to the pre pandemic seasonal average (over a 10-year period) of 10.5% expansion observed in Q2. This reflects slower pace of disbursal of revenue expenditure. Excluding interest payments and subsidy disbursals, central government’s revex contracted sharply by 22.6% QoQ. Although additional expenditure commitments have increased during the course of the year (predominantly on account of food and fertiliser subsidies), the central government appears to be keeping a lid on other forms of consumption expenditure to mitigate overall fiscal risks.
• With import of goods outpacing that of exports, the net export ratio deteriorated to -8.6% of GDP in Q2 FY23 (the widest in over 9-years), from -8.1% in Q1. This is in line with the increase in monthly merchandise trade deficit during Q2 amidst healthy domestic demand and lagged impact of higher commodity prices.
  
• On the supply side, headline GVA depicted a similar trend. Annualized growth decelerated sharply to 5.6% YoY in Q2 FY23 from 12.7% in Q1. In contrast, GVA expanded by 1.9% QoQ in Q2 FY23, better than the pre pandemic seasonal average (in the new data series with 2011-12 as base) of -0.3% observed in Q2.
  
• Agriculture and allied sector posted a surprisingly strong expansion of 4.6% YoY, a 10-quarter high. This strong performance is despite the anticipated drag from lower kharif output. It is likely that non-farm activities could have provided a strong offsetting impact during Q2.
  
• Industry GVA contracted by -3.1% QoQ, worse than the pre pandemic seasonal average (in the new data series with 2011-12 as base) of -1.8% observed in Q2. Barring construction, sequential weakness was broad based across mining, manufacturing, and utilities sector. Uneven rainfall, high manufacturing input inflation, weakness in export linkages, subdued rural demand, etc. seems to have weighed on industrial sector.
  
• In contrast, services GVA turned out to be the mainstay with robust expansion of 8.7% QoQ compared to the pre pandemic seasonal average (in the new data series with 2011-12 as base) of 4.7% observed in Q2. The combination of pent-up demand, pre festive season activity, and traction in IT exports seems to have provided strong support, esp. to Trade, Hotels, Transport, and Communication Services.

Outlook

Cumulatively, GDP growth in H1 FY23 has come at a robust level of 9.7% YoY. Although favorable statistical base effect has an important role to play here, pick-up in sequential activity is commendable despite heightened geopolitical uncertainty, tightening of global financial conditions, and persistence of supply chain disruptions in certain commodities, highlighting the resilience in the domestic economy.  

Having said so, challenges for economic growth are expected to intensify in H2 FY23 and FY24.

• Despite some paring of expectations with respect to the pace of rate hikes by major central banks, monetary policy rates could remain higher for longer. In case of US, the Federal Reserve in its upcoming review in Dec-22 is expected to telegraph a higher terminal rate projection of 5.00-5.25% compared to the earlier level of 4.50-4.75% provided in Sep-22.

o    This could imply persistence of tightness in global financial conditions.

• In its latest update to the World Economic Outlook report, the IMF slashed its growth forecast for 2023 World GDP and World Trade by 20 bps and 70 bps to 2.7% and 2.5% respectively - this marks a sharp loss of momentum vis-à-vis IMF’s 2022 growth estimates of 3.2% and 4.3% for world economic growth and global trade.

o    The anticipated slowdown in global demand has already started to manifest in weakness in India’s merchandise exports that for Oct-22, posted its first annualized contraction in 20-months.

o    Elevated geopolitical uncertainty could further dampen sentiment and global demand.

Going forward, as the favorable statistical effect tapers, headline GDP growth would decelerate in the coming quarters. However, incremental support would nevertheless come from: 

• Festive season support to private demand, esp. in Q3 FY23. This would get additional support from moderation in inflation and bonus pay-outs and expected hike in dearness allowance for government employees.

• Kharif harvest in Q3 FY23 would offer support to agriculture output and farm incomes. The healthy pick-up in rabi sowing (up 24.1% YoY as of Nov 25^th) bodes well for farm incomes in subsequent quarters.

• Capex oriented public expenditure continuing to offer good quality fiscal impulse, which would likely benefit manufacturing capacity utilization further. For H1 FY23, central government capex spending rose by nearly 49.5% YoY to mark the fastest pace on record.

• Softness in global commodity prices (CRB index is ~15% lower vis-à-vis Jun-22 peak) would support producer profit margins, and their gradual pass-through would boost consumer sentiment.

We expect the downside and upside risks to be broadly balanced in the coming quarters. As such, we continue to maintain our FY23 GDP growth forecast of 7.0%.

Table 1: India’s GVA and GDP: Sectoral break-up