Ambiguities in Q2 GDP numbers

The GDP data which came out for Q2 are impressive as it does indicate that India is set to overshoot the 6.5 per cent growth rate projected by the RBI. This is notwithstanding the fact that Q3 will be impacted by lower kharif crop and Q4 probably by a similar outcome for the rabi crop.

There are, however, some interesting questions which can be raised when one looks at these numbers, as they are not apparently aligned with economic theory.

To begin with, a look at what monetary policy has to say. Higher interest rates are supposed to slow down demand for goods and services, which in turn will bring down prices. In India we have a situation where the repo rate has been increased by 250 basis points (bps) since May 2022 and the weighted average lending rate has gone up by around 200 bps. But this has not quite come in the way of GDP growth, which continues to surprise on the upside.

In fact, credit has been bolstered by growth in personal loans which means that people are not really deterred by higher interest rates and continue borrowing even if it is for consumption. Personal loans are reckoned on the basis of the external benchmark interest rate which is normally the repo rate. This means that if the repo rate has gone up by 250 bps, all home loans would have increased by the same amount. Yet, demand is bright.

Two explanations

There are two explanations here. The first is that people do not borrow for a house or vehicle because of the interest cost but on account of the need or desire and the cost of the purchase. Hence, while interest rates can alter the borrowing cost, it may not be affecting the final decision. The same holds for companies which do not stop investing if the market is good and more investment has to be made.

The second explanation is that while the RBI has increased interest rates from 4 per cent to 6.5 per cent, it has actually come back to normal in real terms. Lowering the repo rate to 4 per cent was due to exceptional conditions; now that things have normalised, the repo rate is actually at an equilibrium rate.

This looks plausible if we link the same to the real interest rate hypothesis which says that what matters is the real and not nominal rate. When the repo rate was 4 per cent and inflation was 6-7 per cent, then the real interest rate was negative, which was abnormal.

The second aspect of the GDP numbers which has caused some excitement is the growth in the manufacturing sector at 13.9 per cent. The number is quite phenomenal.

But what is is bewildering is that the corporate sector has actually registered negative growth in turnover this quarter. However, profits have boomed because of falling input costs. GDP is calculated as value added, which is defined as the sum of profits, salaries and wages. Therefore, when GDP goes up for manufacturing, the main factor is profits.

But sales have actually fallen (BoB’s study on corporate results of 2,749 companies show a decline of 0.5 per cent for non-BFSI sector). Therefore, there is a case of companies not being happy with the growth in sales, which is due to lower demand conditions and comes in the way of future investment. Yet, they have contributed very well to the GDP.

The opposite is seen when one views growth in the financial services segment where it was 6 per cent. The banking sector has been doing extremely well this quarter with growth of almost 18 per cent in credit and 14 per cent in deposits.

The methodology followed uses price deflators which lowers real growth in this sector. The same holds for trade, transport, hotels, etc., where proxies used are GST collections and income statements of companies. Growth was just 4.3 per cent. Now, GST collections have been increasing by the month.

Micros vs macros

The main point here is that at times the micros do not fit into the macros. Most companies in the consumer goods space have articulated that demand has been good for premium products and not general category goods.

Yet, GST collections, which is based on consumption, have been quite robust and do not fit in with the corporate view. Consumption growth has been lower than the tax collections.

Hence, it is hard to get a true sense of what is happening on the consumption side. Bank credit growth, GDP data on private final consumption spending and GST collections do not exactly match each other. It is possible that rising GST collections reflect better compliance and higher inflation, rather than consumption growth.

The investment part of the piece is also interesting. The gross fixed capital formation rate has improved to 30 per cent in Q2 (at current prices). Growth in nominal terms is 12.5 per cent and 9.9 per cent in real terms. This is a fairly good rate of increase.

Yet, if one looks at the financing part of the story, things are a bit fuzzy. Credit to the large manufacturing sector has increased by just 6.5 per cent which means that while there is investment taking place, it is not broad based.

What does all this mean? There is a difference between plain statistics and ground level developments. This is natural given that several proxies are used when calculating the GDP. The views which one gets from monthly economic releases generally pertain more to the formal sector which may not be not fully representative of what goes on in the economy. There are several positive developments for sure, yet there are cautious undertones in the commentaries of corporates.

Further, while there is optimism on growth numbers, the range spoken of is still less than last year’s.

The tone was different in the middle of last decade when growth was 8 per cent per annum.

The goal will be to get back on this path and sustain the same for a period of at least five years. There is reason to believe that this is possible given the strong policy framework in place in almost all sectors.

The writer is Chief Economist, Bank of Baroda. Views are personal

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