India Q2GDP Review: Indian Economic Engine Resilient in the Face of Headwinds

Figure 1: India GDP growth (% y/y) 

Source: National Statistics Office, Continuum Economics

In line with our expectations, India’s Q1 FY24 (Q2 2023) growth came in at 7.8% y/y driven by high capital expenditure and robust service sector activity. Government spending, given a fairly generous outlay in the FY24 budget, has been high throughout the quarter, and has to some extent prompted a recovery in private investment as well. Capital investment contributed a substantial 2.8 percentage points to the overall growth, building upon the 3.1 percentage points contributed in the first quarter of the year. Meanwhile, consumer spending proved to be a consistently strong contributor to growth, and increased its contribution to 3.5 percentage points, up from 1.6 percentage points in the previous quarter. Private consumption recorded a 6% y/y growth.

However, not all aspects of the economy contributed positively. Net exports were a substantial drag during the period. Although, a fall in exports typically leads to a large inventory build-up, this time it hasn't manifested as such. This was also corroborated by the latest PMI data, which highlighted that finished goods inventories continued to deplete over the quarter. 

Taking a closer look at the sectors driving growth, it's evident that the service sector, not industry, is the main engine for India's economic expansion. This aligns with the earlier observation regarding strong consumer spending. Granular data showed 12.2% y/y growth in financial, real estate and professional services. Meanwhile, construction saw an 8.5% y/y growth. Agriculture contributed slightly less in this quarter, potentially reflecting erratic monsoons this year. We remind our readers that the onset of the monsoon was delayed in June, limiting the sector’s activity. Manufacturing activity remained resilient growing at about 4.7% y/y. 

In light of these economic dynamics, it is unlikely that the Reserve Bank of India (RBI) will rush to cut interest rates. India's robust growth trajectory is expected to continue in the coming quarters, with an estimated full-year growth rate of approximately 7%. Even for the following year, a growth range of 6-7% seems likely. The recent increase in inflation is primarily driven by food prices, but early signs suggest that this is transient. Therefore, given the current growth backdrop, there is little urgency also for the RBI to tighten rates in response to inflation. In fact, once inflation numbers stabilize, the 6.5% policy rate may start to appear relatively restrictive. While rate cuts could be on the horizon, they are likely to be postponed until next year. There are several potential headwinds on the horizon that could slow down India’s growth though. These include the impact of RBI's rate hikes and liquidity tightening measures, the increasing likelihood of El Niño and food grain shortages, and the possibility of a global economic slowdown. These factors may add complexity to India's growth narrative in the coming quarters.