With India’s 2009-10 Q2 GDP estimates showing a spectacular rise of 7.

9 per cent over the second quarter of previous year, is it time to open the champagne and start celebrating? This article analyses the key drivers of the robust GDP numbers and what is the road ahead for GDP and what kind of policy response is likely from both the central bank & the central government.

Rama Krishna Vadlamudi

December 1st, 2009

The GDP estimates from the Central Statistical Organisation (CSO) show that the country’s Gross Domestic Product (GDP) has grown by 7.9 per cent during the second quarter (Jul-Sep 2009) of this fiscal year 2009-10, beating consensus forecast of around 6.3 per cent by a wide margin. This has come as a welcome surprise to financial markets which were reeling under the Dubai Debt Crisis last week. This has given a big boost to sentiment in the stock markets on Tuesday, that is, November 30, 2009, with the Sensex closing at 16,926 points, up 1.8%. So, is it time to open the champagne as far as economy is concerned? Or, is it time to remain cautious? The second quarter GDP growth is led by manufacturing and services sector, with a big booster from mining sector (due to increased gas output from KG basin). Even private consumption and government expenditure have boosted the economy to some extent. Moreover, agriculture had clocked a growth of 0.9 per cent despite drought conditions exacerbated by flash floods during the last quarter. The immediate consequence for the excellent GDP numbers is that the RBI may be tempted to start raising interest rates much earlier than expected. It may spur the RBI to raised CRR at least by 50 points by the end of December, even as inflationary pressures are building up in the economy in the form of higher food inflation, which is at a record high of 15 per cent now. The higher GDP numbers also indicate the government authorities will scale up the GDP forecast for the full year 2009-10, from the present 6.5 per cent up to 7 per cent or a little lesser and concomitantly will have to start thinking about winding down their fiscal stimulus sooner than later. This article analyses the factors driving the numbers and what the future holds in terms of GDP for the fully year and the outlook on interest rates:

Rama Krishna Vadlamudi, BOMBAY.


Dec. 1st, 2009 Page 1 of 8

What are the highlights of the Second Quarter GDP?
GRAPH 1: Quarterly GDP growth rate %:
India’s GDP is estimated to have grown by nd 7.9 per cent during the 2 quarter of fiscal 2009-10 This is a big surprise for the markets as the figure is much above the expected figure of 6.3 per cent The stupendous GDP growth rate of 7.9 per cent is led by manufacturing sector Mining and electricity sectors have given a big boost to the GDP numbers, while construction has slowed down a bit
* GDP at factor cost at constant prices (1999-2000)

GRAPH 2: Half-yearly GDP growth rate %:
The GDP has recorded a growth of 7 per cent during the first half of fiscal 2009-10. This is against the 5.8 per cent recorded during the second half of 2008-09 and 7.8 per cent exhibited during the first half of 2008-09 Gas output from Reliance Industries’ KrishnaGodavari Basin (DG) has boosted the performance of Mining segment in Q2 High Government expenditure funded almost funded by huge borrowings gave a fillip to GDP
* GDP at factor cost at constant prices (1999-2000)

GRAPH 3: QUARTERLY GDP NUMBERS (Rs ‘000 crore): As can be seen from the Graph 3 depicted below, India’s Gross Domestic Product was projected at Rs 8,34,800 crore during the second quarter of fiscal 2009-10, that is for July-September 2009. This is against the GDP of Rs 7,73,900 crore achieved during the second quarter of 2008-09, showing a robust growth of 7.90 per cent year on year. These GDP figures are at factor cost at constant prices (base year 1999-2000).

Rama Krishna Vadlamudi, BOMBAY.


Dec. 1st, 2009 Page 2 of 8

Quarterly GDP numbers *
950.0 Rs '000 crore 900.0 850.0 800.0 750.0 700.0 Q2 Jul-Sep Q1 Apr-Jun Q4 Jan-Mar Q3 Oct-Dec Q2 Jul-Sep Q1 Apr-Jun 834.8 830.6 773.9 782.6 902.9


* GDP at factor cost at constant prices (1999-2000)


What are the factors that contributed to the spectacular numbers?
The 7.9 per cent GDP growth rate was spurred by a good show put up by manufacturing, mining and services sector Manufacturing has grown by 9.2 per cent against 5.1 per cent achieved in Q2 of 2008-09 Mining and quarrying sector (bolstered by Reliance Industries’ KG basin gas output) has risen by 9.5 per cent versus 3.7 per cent recorded during Q2 of 2008-09 (at full output, the KG basin’s gas output alone is expected to add 0.3 per cent a year to the country’s GDP) Services sector has shown a growth of 9.3 per cent against 9.8 per cent registered in Q2 of 2008-09 Construction has grown by 6.5 per cent (9.6 per cent) signifying a slowdown Agriculture growth also stood at 0.9 per cent against the expectations of a negative growth Private consumption has picked up Obviously, the impact of drought has not got reflected in the second quarter of this year in Agricultural GDP. The impact may be severe during the third quarter of this year affecting the Agricultural output in a substantial way. As per the official estimates, output of rice, coarse cereals, pulses and oilseeds is expected to decline by 18, 20, 7 and 15 per cent respectively during the Kharif season of 2009-10 as compared to the Kharif season in 2008-09. (Kharif season in India accounts for about 65 to 70 per cent of India’s agricultural output. The farm sector itself accounts for 17 per cent of India’s GDP.)

Rama Krishna Vadlamudi, BOMBAY.


Dec. 1st, 2009 Page 3 of 8

Private consumption (technically called Private Final Consumption Expenditure, or PFCE) has also picked up. It has gone up by 5.6 per cent, showing an upward trend and tremendous improvement against 1.6 per cent in the previous quarter. There seems to be some impact of government’s fiscal stimulus, government spending, and the sixth pay commission payments which have put more money in the hands of consumers. This is reflected in the strong sales put up by automobile companies and consumer durable firms in the last quarter. Government spending has gone up by 27 per cent. Gross fixed capital formation (GFCF) is showing tremendous signs of improvement with GFCF showing an increase of 7.3 per cent year on year (4.2 per cent previous quarter) and the momentum in the investment climate may continue going forward. The manufacturing sector growth is also mirrored in the figures of Index of Industrial Production (IIP), thus making it a sustainable industrial recovery. Moreover, what is aiding the economy is the loose monetary policy (low interest rates) pursued by Reserve Bank of India with the availability abundant liquidity in the banking system. And then there is some sort of normalcy in the world markets giving a boost to foreign portfolio inflows and direct investment.

What is the impact on Bond markets?
The strong show put up by the second quarter GDP has impacted the bond markets negatively. With the GDP increasing at a pace much above the 6.5 per cent put up by the RBI in its second quarter review of Annual Policy (released at the end of October last), the RBI may be tempted to increase the CRR or LAFRepo rate in order to withdraw its accommodative monetary policy stance. However, GDP growth rate is not the only factor RBI considers while adminstering the monetary policy instruments. With food inflation nearing 15 per cent and inflationary pressures building up in the system, RBI may resort to some rate hikes as early as December-end if not January. Another concern is the impact of drought on farm output and consequent pressure on food inflation. The bond prices reacted to the news of robust GDP numbers immediately with the 10-year benchmark yield going up by more than seven basis points over the previous day’s close, with a dip in the price of about 45 paise. The 10-year 6.90 per cent (July 2009 maturity) paper ended with a price of Rs 97.99 (previous day Rs 97.54) with the yield closing at 7.26 per cent (7.19 per cent previous day). Bond prices may further weaken in the next few months, as the RBI tries to recalibrate its nuanced stance on the monetary policy in view of the GDP growth.

Rama Krishna Vadlamudi, BOMBAY.


Dec. 1st, 2009 Page 4 of 8

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How do the robust Q2 numbers affect stock markets?
After the announcement of GDP numbers, stock markets have reacted positively to the news. The surprise GDP growth rate over and above the consensus estimates has boosted the confidence of investors in the stock markets. There are several upgrades for GDP numbers for the current year as well as for the year 2010-11. Till now, the GDP growth rate for the full year was estimated at around 6.5 per cent. With the second quarter GDP growth recording 7.9 per cent, the marketmen seem to be scaling up their GDP estimates to between 6.5 per cent and 7 per cent. This positive sentiment among the investor community will keep the domestic stock indices in good stead for the next few weeks. Even Government authorities may scale up their 2009-10 GDP estimates.

What is the impact of strong GDP on currency?
Following the announcement of GDP numbers, the rupee appreciated against the US dollar. Of course, stock indices going up also caused the rupee to appreciate. The strong GDP numbers will be positive for the rupee. Even as the world was showing some feeble signs of recovery from the severe economic downturn, the seven per cent GDP growth is very good for India.

Rama Krishna Vadlamudi, BOMBAY.


Dec. 1st, 2009 Page 5 of 8

Only a few countries, like, China (which clocked 8,9 per cent growth in Jul-Sep 2009 quarter), Indonesia, etc, are showing good GDP growth this year. With the US Fed expecting to continue its near-zero interest rate policy for the next three to four quarters, Indian currency may be ripe for some more appreciation in future given the positive sentiment in the stock markets and huge inflows continuing in future. However, any hawkish stance from the US Fed or the ECB or BOE for that matter may negate this view. The rupee on Tuesday ended at 46.50 (previous day closing 46.57) against the US dollar, which itself has been weakening against other major currencies, Euro and JPY. All indications are that the rupee may strengthen against the US dollar if not against the Euro.

Will RBI hike the interest rates?
The strong GDP estimates for the second quarter have fuelled speculation in the markets that the Reserve Bank of India will be forced to raise CRR, if not the LAF-Repo rate in the immediate future, that is, by December-end. The opinion among the economists and experts seem to be divergent. While some argue that RBI is behind the curve in raising interest rates; with spiraling inflationary pressures building up in the economy. There are some economists who argue that RBI should wait for some time before taking any rate decision. Agriculture continues to be weak with the weakness showing up only in the third quarter GDP. With food inflation soaring to 15 per cent and Kharif production expected to show a decline of more than 15 per cent for the full year, RBI may be tempted to increase the Cash Reserve Ratio for commercial banks by at least 50 per cent by as early as the end of December 2009, even as Montek Singh Ahluwalia, deputy chairman, planning commission, maintains that there is no serious concern on inflation as of now and conventional monetary policy was unlikely to be effective in curbing food price rise. Reserve Bank of Australia has on Wednesday raised its key interest raise by 25 basis points to 3.75 per cent, the third successive raise this month from RBA, since September 2009. Even European Central Bank may consider a rate hike from the present one per cent this month, as the euro zone inflation shows a positive 0.6 per cent. The rate decisions will also affect RBI’s money policy.

Will GDP for the full year 2009-10 cross 7 per cent?
Agriculture may spoil the sport for the GDP growth in the immediate future. Going by the Ministry of Agriculture’s own estimates, food grain production declined by about 18 per cent, and oil seeds by 15 per cent. The fact is that it did not get reflected in the second quarter agricultural numbers. So, agricultural growth is much higher in the second quarter numbers than the street estimates.

Rama Krishna Vadlamudi, BOMBAY.


Dec. 1st, 2009 Page 6 of 8

As such, the drought impact may spill over to the third quarter, and farm output may actually show a decline. Several independent estimates suggest the total farm output mayy decline by more than 15 per cent in 2009-10. Rice production seems to have been impacted severely this year. It’s no wonder then that the government is contemplating rice imports for the first time in the last 20 years. If and when the government decides to withdraw the stimulus measures, the GDP numbers may not get a boost from the government spending. Going forward, the government may not be able spend heavily on subsidies and other programmes. With the RBI expecting to raise interest rates, the benign interest rate regime may come to end sooner than later. But having said, one positive development is that private consumption has also picked up. Investment demand seems to growing with the gross fixed capital formation showing a growth of 7.3 per cent. So, even if the government decides to follow an exit strategy for its fiscal measures, the growth from private sector in the form of new investments and private consumption may give a fillip to the economy in the future. What is the road ahead for GDP growth: Is it time to revise upwards India's economic growth forecast for the full year 2009-10 as GDP data showed a faster expansion in July-September quarter? The country’s chief statistician and secretary of the ministry of statistics and programme implementation (MOSPI), Dr Pronab Sen is of the opinion that for full year, India’s GDP growth rate may be above seven per cent. His optimism is predicated on signs of recovery in world growth, economic stimulus showing its impact on growth, investments are going up substantially and private consumption is improving vigorously. However, the following table presents an interesting contrast:

QUARTER FIN. YEAR 2009-10 2008-09 2007-08 2006-07 2005-06 2004-05 2003-04 5.80 8.60 9.80 10.30 9.00 8.10 Q4 Q3 5.80 9.30 9.40 9.70 5.30 11.30 Q2 7.90 7.70 9.00 10.20 8.90 7.40 9.00 Q1 6.10 7.80 9.20 9.70 9.10 8.30 5.40 5.8 8.9 9.6 10.0 7.2 9.7 H2 HALF-YEAR H1 7.0 7.8 9.1 9.9 9.0 7.8 7.2 6.70 9.00 9.70 9.50 7.50 8.50 FULL YEAR

* GDP at factor cost at constant (1999-2000) prices

Interestingly, from 2003-04 to 2008-09, economy's growth was much better in the first half, rather than in the second half in four out of six years; contrary to the popular belief (rather myth) that GDP growth would be much better in the second half, the so-called busy season of the financial year. But data are data and nobody can deny that! May be, this data needs further refining, probing and further interpretation from experts.

Rama Krishna Vadlamudi, BOMBAY.


Dec. 1st, 2009 Page 7 of 8

The crucial quarter this year could be the third quarter (Oct-Dec 2009) GDP numbers. Before jumping into any conclusion about any growth rate of the full year, some economists are cautioning that we need to wait till the third quarter GDP estimates are out (The third quarter GDP estimates are slated to be published on February 26, 2010.) As the Graph 3 on page 3 above indicates, the base for third and fourth quarter of last year (2008-09) seems to be very high with the third quarter Oct-Dec 2008 GDP at Rs 8,80,000 crore and the fourth quarter Jan-Mar 2009 GDP at Rs 9,02,900 crore. Interestingly, these figures are much higher than the Jul-Sep 2009 quarter GDP of Rs 8,34,800 crore. (All these GDP figures are at factor cost at constant prices – 1999-2000.) This is very significant and going by the present macro economic indicators, the overall picture seems to be that the India’s chances of achieving a GDP growth of seven per cent for the fully year are somewhat drab, if not impossible – unless some positively dramatic developments happen in the US or Europe. May be, the time is not yet for the government to withdraw all the fiscal measures in a hurry. Government would be willing to wait till the end of February 2010 to take a decision on the fiscal exit, by which time the Union Budget 2010-11 presentation also would be ready. The next policy action from the government may wait till the end of February next year. Meanwhile, RBI may start tightening the screws on liquidity front and it may increase the Cash Reserve Ratio (CRR) for banks by around 50 per cent as early as the end of December. The action on the LAF-Repo front may wait for some more time. RBI seems to be behind the curve, some experts contend. However, RBI may have to tread a cautious path between the twin objectives of spurring growth trajectory while maintaining price stability in the economy. Even Montek Singh Ahluwalia, deputy chairman, planning commission, feels that RBI’s monetary policy may not be the right thing to control food inflation at this point of time. Meanwhile, it is better to keep our fingers crossed! Date source: CSO-Central Statistical Organisation Graphics: Author

Rama Krishna Vadlamudi, BOMBAY.


Dec. 1st, 2009 Page 8 of 8

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