Published on 1/12/2017 10:06:51 AM | Source: Motilal Oswal Securities Ltd

2QFY18 real GDP growth in line with estimate - Motilal Oswal

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2QFY18 real GDP growth in line with estimate

Farm sector weakness to bring GVA growth to sub-6% in 3QFY18

* Real GDP growth picked up to 6.3% YoY in 2QFY18, in line with our estimate of 6.4% and up from its three-year low of 5.7% YoY in 1QFY18. Our theme of ‘consumption-driven to investment-led’ is finally playing out, as consumption grew at the slowest pace in two years, while investments grew at the fastest pace in five quarters.

* Real GVA growth of 6.1% YoY too was in line with our estimate of 6.2% and much better than 5.6% growth in the previous two quarters, primarily led by higher manufacturing growth (7% v/s 1.2% in 1QFY18), which entirely offset the weakness in services (+7.1% YoY in 2QFY18 v/s 8.7% in 1QFY18).

* According to the first advance estimates of the Department of Agriculture released in late Sep’17, notwithstanding normal monsoon, food grains production in the Kharif season is estimated to have declined 2.8% in FY18, marking the sharpest contraction in eight years. Consequently, we have revised down our forecasts for agricultural activities.

*  Accordingly, we expect real GVA growth to fall below 6% YoY again in 3QFY18 before picking up to ~6.5% in 4QFY18. This implies real GVA growth of 6.0% for the full-year FY18, down from our earlier estimate of 6.4%. It also means that real GDP is likely to grow 6.3% in FY18, down from our earlier estimate of 6.7%. I.

GDP growth highest in three quarters…

* Real GDP growth at 6.3%…: In line with our expectation of 6.4% (and consensus of 6.4%), real GDP growth came in at 6.3% YoY in 2QFY18, marking its highest growth in three quarters and recovering from 13-quarter lowest growth of 5.7% in 1QFY18 (Exhibit 1).

* …driven primarily by net exports: Exhibit 2 shows that while government consumption expenditure was the biggest drag on GDP growth in 2QFY18 (+4.1% YoY v/s 17.2% in 1QFY18) and private consumption expenditure (PCE) grew at the slowest pace in eight quarters (at 6.5% YoY), imports grew much slowly at 7.5% in 2QFY18 v/s 13.4% in 1QFY18. Consequently, net imports deducted only 1.3 percentage points (pp) from real GDP growth, as against 2.6pp in 1QFY18.

* Growth drivers shifting from consumption to investments: Further, as we have discussed in detail, while consumption growth has eased substantially in 2QFY18, real investments (GFCF + change in inventories) have grown faster. Consequently, the gap between consumption and investments has narrowed substantially in 1HFY18 (Exhibit 3). Without fiscal consumption spending, GDP growth at 6.6% YoY in 2QFY18 (v/s 4.3% in 1QFY18) was the highest in five quarters (Exhibit 4)

. II. …and GVA growth also crossed 6%

 *GVA grows 6.1% YoY in 2QFY18 led by better manufacturing growth: Growth in real GVA also picked up from 5.6% YoY in each of the past two quarters to 6.1% in 2QFY18 (Exhibit 5). Better GVA growth was largely driven by the manufacturing sector, which more than offset the weakness in the services sector (Exhibit 6).

III. Consumption-driven to investment-led theme playing out

* Overall, it appears that our theme of ‘consumption-driven to investment-led’ is playing out (although earlier than our anticipation). With consumption slowing and investments growing faster, real GDP growth has eased from 7.7% in 1HFY17 to 6% in 1HFY18 (Exhibit 7).

*  Importantly, while investment growth has picked up from a very low base (from 1.7% in FY17 to 8.5% in 1HFY18), investments have fallen marginally from 30.6% of GDP in 2QFY17 to 30.5% in 2QFY18 (Exhibit 8). Considering the improvement in external trade, it implies that gross domestic (implied) savings have fallen from 29% of GDP in 2QFY17 to 27.8% in 2QFY18.

IV. GVA growth to fall below 6% in 3QFY18 on account of weak farm sector…

* While 2QFY18 GVA (and GDP) growth was better than in the previous few quarters, we expect economic activity growth to decelerate in 3QFY18 before picking up in 4QFY18. The key reason for deterioration in 3QFY18 would be the farm sector. According to the first advance estimates released by the Department of Agriculture, Cooperation and Farmers Welfare, production of food grains is estimated to have declined 2.8% in FY18, marking the highest contraction in eight months (Exhibit 9).

* Consequently, real GVA growth is likely to be 5.8% YoY in 3QFY18 and real GDP growth would be ~6.1% in the current quarter. Although the headline numbers will be lower, we believe that the non-farm sector will continue to grow faster in 2HFY18 (at 7.1% and 7.5% in 3QFY18 and 4QFY18 respectively, versus 6.4% YoY in 1HFY18). Real GVA growth is expected to recover to ~6.5% in 4QFY18, which implies growth of ~7% in real GDP.

V. ...which also implies downward revision in full-year FY18 GVA/GDP forecast by 40bp

* Notwithstanding normal monsoon in June-September 2017 (95.1% of long-run average), weak rainfall in the latter part of the season and unfavorable spatial distribution have led the Department of Agriculture to come up with their first advance estimate of Kharif season food grains production showing worst contraction in eight years.

*  Accordingly, we have revised down our FY18 agricultural sector growth forecast to ~1.5% from 4% earlier. With a weight of ~15% in headline GVA, it implies a downward revision of 38bp in real GVA growth forecasts. Consequently, we revise down our FY18 real GVA growth forecast from 6.4% to 6%, and real GDP growth forecast to 6.3% from 6.7%.


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