Q2 GDP growth at 4.5% is the lowest level in the last 6 years

The only good thing about the GDP growth of 4.5% for the September quarter was that the expectations were much lower. Most economists had pegged the second quarter GDP closer to 4.2% with some pessimistic notes even pegging the growth at below 4%. From that perspective, the GDP looks to be OK, but that is small consolation. What exactly drove the GDP lower and what does it mean for the future?

Agriculture and manufacturing

The agriculture growth for the second quarter came in at just 2.1%, sharply lower compared to 4.9% recorded in the second quarter last year. The Modi government has been targeting at least 4% growth in agriculture to reach its target of doubling farm incomes by 2022. Also, most of the growth came from forestry and fisheries with basic cropping remaining weak. The second big disappointment was manufacturing. At negative de-growth of (-1.1%), the manufacturing fall has been sharp over the previous year. Industries like metals, automobiles and capital goods have seen visible pressure on their ability to produce. The weak manufacturing can be attributed to a combination of major funding related issues as well as weak demand. Consumption demand has taken a hit due to uncertainty on the growth and the jobs front. Most of the growth has actually come from services with public services contributing a big chunk to the GDP growth in Q2.

PFCE and capital formation

The real challenge to the GDP numbers was already visible after the IIP and the core sector growth dipped into negative territory for two months in succession. One aspect of the fall in GDP is the sharp fall in private final consumption expenditure (PFCE). That is evident in the demand for a number of products ranging from automobiles, two-wheelers and FMCG products. In fact, PFCE fell to 5.1% in Q2 from 9.8% last year. At the same time, the Gross Capital Formation (GCF) also fell from 11.8% last year to (-3.0%) in the current year. These two numbers, perhaps, best capture the crux of the GDP slowdown. There is pressure on consumption as also on capital formation.

Policy response to GDP

Clearly, the combination of weakening PFCE and weakening GCF imply that the industry requires a fiscal and monetary push. A rate cut by the RBI in December now almost looks like a foregone conclusion. But even the tone could become more dovish. On the fiscal front, the government could look to fast track and simplify GST reforms as well as fiscal incentives for new production facilities. Clearly, rate cuts alone will not work and a bigger quantum reforms push is the need of the hour. Full year GDP may end up around the 5% mark in a best case scenario, at least going by the IIP and core sector numbers!