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. www.scribd.com/vrk100 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’ Krishna-

Godavari 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. www.scribd.com/vrk100 Dec. 1st, 2009 Page 2 of 8

 Quarterly GDP numbers *

950.0
902.9
900.0 880.0
Rs '000 crore

834.8 830.6
850.0
800.0 773.9 782.6

750.0
700.0
Q2 Q1 Q4 Q3 Q2 Q1

Jul-Sep Apr-Jun Jan-Mar Oct-Dec Jul-Sep Apr-Jun

2009-10 2008-09

* 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. www.scribd.com/vrk100 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 LAF-
Repo 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 re-
calibrate its nuanced stance on the monetary policy in view of the GDP growth.

Rama Krishna Vadlamudi, BOMBAY. www.scribd.com/vrk100 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. www.scribd.com/vrk100 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. www.scribd.com/vrk100 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:

TABLE 1: QUARTERLY GDP GROWTH RATES %:

QUARTER HALF-YEAR FULL YEAR

FIN. YEAR Q4 Q3 Q2 Q1 H2 H1

2009-10 - - 7.90 6.10 7.0 -

2008-09 5.80 5.80 7.70 7.80 5.8 7.8 6.70

2007-08 8.60 9.30 9.00 9.20 8.9 9.1 9.00

2006-07 9.80 9.40 10.20 9.70 9.6 9.9 9.70

2005-06 10.30 9.70 8.90 9.10 10.0 9.0 9.50

2004-05 9.00 5.30 7.40 8.30 7.2 7.8 7.50

2003-04 8.10 11.30 9.00 5.40 9.7 7.2 8.50

* 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. www.scribd.com/vrk100 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. www.scribd.com/vrk100 Dec. 1st, 2009 Page 8 of 8