beyondbrics

By Frederic Neumann, co-head of Asian economics research at HSBC

Ok, buckle up

India’s first quarter GDP is up sharply.

Forget talk about drought and global financial jitters. India’s economy is shaking off such obstacles with apparent ease. Output expanded briskly in the first quarter of this year, and the economy grew more rapidly late last year than initially estimated. Investment and manufacturing have powered the expansion so far, with consumption and services still lagging the advance. The details suggest that growth could be stronger still in the coming quarters, lending yet more urgency to rate hikes by the RBI.
Facts

The economy expanded 8.6% y-o-y in the first quarter, up from a revised 6.5% (previous estimate was 6%). This was squarely in line with expectation, but below our more bullish forecast. On a sequential basis, output rose 3.6% q-o-q sa, a respectable pace by any measure. Even if the headline number was in line with consensus, the details point to still stronger growth ahead. First, investment, partly due to infrastructure spending and partly by private firms, rose 17.7% y-o-y in the first quarter, up from 8.8% previously. With capacity constraints ever more apparent, and the financial environment conducive to expansion, we suspect that investment spending will hold up well in the coming quarters.

Second, consumption disappointed, rising a mere 2.6% y-o-y (down from 5.3%). This, presumably, reflects in part soaring food prices, which eroded real disposable incomes and made shoppers generally more cautious. With agricultural prices now easing, we expect consumption to get a real kick over the coming quarter, helped, too, by rising incomes as a tightening labor markets spurs wage growth.

Third, on the production side, agriculture rose a mere 0.7% y-o-y, up from -1.8% in the fourth quarter of 2010, but still well below the sector’s potential. Assuming rains remain accommodative, output should add another boost to the economy in the coming months.

For FY 2010, GDP growth came in a 7.4%, ahead of our and the government’s forecast (7.2%). For this year, we initially penciled in 8.5% growth, slightly above consensus (8.3%). So far, the high-frequency data suggest that momentum is holding up well; so our more optimistic forecast may well turn out to be too conservative.

Implications

No doubt, the RBI is studying these numbers in great detail. They should add some urgency to the tightening cycle: with growth likely to turn out higher in the coming quarters than initially expected, rate hikes may well be moved up. In fact, we’ve long highlighted that easing headline inflation is mainly due to the sequential decline in food prices and doesn’t signal a cooling of underlying price pressures. From this perspective, stronger growth should lead to more rapid rate hikes. In fact, we continue to call for a surprise rate hike before the next RBI meeting in late July. Sure, the Euro jitters may have left policy-makers across the world in a more accommodating mood, but in India tightening is now needed to avoid a hard landing later on.

The other implication of this data is for the economy’s external balance. Over the past few months, the trade deficit has widened sharply. To be sure, today’s GDP numbers underline that this is more a price rather than a volume effect (real imports actually fell compared to last year, while exports rose). But, that’s not entirely re-assuring: domestic demand hasn’t fully taken off yet, with consumption and service growth especially bound to accelerate. As domestic demand growth outstrips demand overseas, the trade deficit may widen sharply. In fact, our FX strategists have, partly for this reason, highlighted the INR as one of the currencies in Asia likely to underperform.

Bottom line: In line with expectations, but bullish in details: today’s GDP reading highlights the need for urgent monetary tightening, global financial jitters notwithstanding. India’s external position, too, may increasingly become lopsided if domestic demand growth is not curtailed with rate hikes. Sure expectations of such have receded, but we’re not entirely prepared to give up on our call of a surprise hike before the July 27th RBI meeting. Buckle up, India is flying.