ExplainSpeaking: What explains India’s surprisingly fast GDP growth and the ongoing surge in Sensex?

But right through 2023, India’s GDP growth has beaten street expectations — none more so when it clocked 7.6% in the quarter ending September 2023 (also referred to as the second quarter or Q2 of the current financial year).

On the face of it, India’s GDP growth in Q2 was pushed up by strong industrial growth especially in the manufacturing sector, which grew by almost 14% over the same quarter last year [https://indianexpress.com/article/explained/explained-economics/gdp-growth-surprise-how-to-read-the-data-9050696/ ]. It was not clear what had led to this massive jump in manufacturing output beyond the obvious low base effect.

Further, the GDP news came alongside the news of key electoral victories for the ruling BJP, and together the two factors jump started the Indian stock markets. Data reveals that foreign investors are again making a beeline to buy stakes in Indian companies even as domestic retail investor’s involvement reaches historic highs.

However, in sharp contrast to these happy tidings, data also continues to show that the growth in the consumption levels of average Indians continues to struggle. Apart from the broad-based sluggishness in consumption recovery, there is a widening urban-rural divide.

Thanks to the contrasting pictures, every analyst is looking for the exact trigger for the good news. To be sure, the upside surprise in GDP and the skyrocketing stock markets raises several other questions: Is the Indian economy, which was struggling before the pandemic, now completely out of the slowdown phase? Is this the start of a new growth phase? Are Indian companies selling more goods? Are Indian companies witnessing a jump in profits? Do the rosy numbers on GDP tables imply private businesses are finally starting to invest towards creating new productive capacities?

The Answers: Mostly yes, but with some caveats.

A K-shaped industrial recovery

Regular readers of ExplainSpeaking would have read a lot about India’s staging a K-shaped recovery.

Simply put, while on an aggregate the economy seems to have staged a recovery, there are wide gaps within the country. There is a large population of India that continues to struggle with unemployment, stagnant incomes (or even declining “real” wages), and broad-based economic distress while a much smaller albeit significant enough number has seen consumption levels jump even higher than what they were before the Covid pandemic.

This K-shaped recovery in consumption is also showing up in a K-shaped recovery of Indian industries.

On Wednesday, the Economics Research Department of Bank of Baroda, led by Madan Sabnavis, brought out a detailed study that not only explained the reasons why India’s GDP grew surprisingly fast but also provided a sectoral health map of the Indian industries

What led to a jump in Manufacturing output in Q2?

As mentioned earlier, the Q2 GDP showed that the gross value-added (GVA) in manufacturing grew by almost 14%. Measuring value added is one way to calculate India’s GDP. The GVA is a fancy way of counting the returns to different factors of production — labour, capital, entrepreneurship and, to an almost insignificant level, rent.

So when the National Statistics Office compiles data, it uses a proxy indicator: The operating profits of the companies. Of course, this data does not include the salaries and wages that workers get but then it is just a proxy for making an estimate of the overall value added by companies.

Table 1.

Interestingly, the BoB study of 3265 companies found two contrasting trends in the first half of the current financial year (SEE TABLE 1)

A> Net sales of companies registered a paltry growth. Part of this can be explained by the high base effect: the net sales had grown by over 24% in Q2 of last financial year.

B> However, company profits — be it operating profits, or profit before tax or profit after tax — have soared.

Since operating profits jumped, notwithstanding the stagnant sales, the industrial GVA showed a sharp increase.

Table 2.

Often the fast growth of financial companies (such as banks) distorts such data but even if one removes the Banking, Financial Services, and Insurance companies, and looks at only the non-financial companies (SEE TABLE 2), these two contrasting trends become even more stark. In other words, net sales contract both in percentage as well as in absolute terms while operating profits rise even higher.

Chart 1.

At one level, there is a simple explanation why profits soared despite net sales contracting: The sharp fall in input prices — note the fall in “expenditure” in both the Tables. In other words, even though companies did not sell more goods, they still ended up making more profits because the prices of their raw materials plummeted. A reflection of this is the way the wholesale price inflation moderated over 2023 (SEE CHART 1).

What led to the jump in Sensex?

A sharp rise in company profits — apart from boosting the GDP calculation — was also noted by investors as improved company earnings. That, in turn, led to investors buying those stocks and the resultant rise in share prices of the concerned firms. A rise in the companies’ stock prices, in turn, lifted the market indices.

Where is the K-shape in industrial recovery?

According to BoB researchers, there are two aspects of India’s K-shaped consumption recovery. One, the gap between urban and rural demand. Two, even within urban demand, the shift is towards more premium products. To be sure, consumption demand is the biggest engine of India’s GDP growth.

Similarly on the investment side, which is the second-biggest engine of GDP growth, most of the firms that are doing well are ones that are benefiting from the government’s capital expenditure push.

Table 3.

Both these trends are reflection in TABLE 3, which lines up the sectors on the profit and net sales. As such, textiles are still struggling on both counts while infrastructure and banks are growing rapidly.

Do higher profits mean companies are starting to invest more?

It has been possibly the most important economic policy goal for this government to “crowd in” the private sector to start the virtuous cycle of investments and ensure sustainability of economic growth.

Different indicators present a different picture. For instance, the Centre for Monitoring Indian Economy (CMIE’s) project announcement data shows concentration in just some sectors such as transport and communications. “If one looks at the finding side of the story, one finds that for banks, credit off-take to industry continues to lag far behind retail and services sector.” Again, the imprint of uneven recovery is visible.

To get around these problems and get an accurate picture, BoB researchers use a proxy indicator of their own: It is the sum of “Gross Fixed Asset” (which includes land, buildings, equipment etc.) and the Capital Work In Progress (to take care of all the inventory). To get this number they looked at the financial statements of over 1400 biggest countries that in any case do most of the heavy lifting when it comes to creating fresh productive capacities in the Indian economy.

BoB’s analysis reveals that higher profits and rising capacity utilisation levels seem to be incentivising companies in at least some sectors to boost productive capacity.

“Half yearly balance sheets of 1,420 companies show that growth in stock of fixed assets has risen by 7.9% to Rs 32.1 lakh crore in Sep’23 from Rs 29.8 lakh crore in Sep’22,” states the study.

However this growth is unevenly distributed among companies belonging to different economic sectors.

Chart 2.

For instance, as CHART 2 shows, sectors that did better than the average were either the ones that catered to the “premium” consumption demand — such as gems and jewellery — or those that benefitted from government’s capex push — such as infrastructure and construction materials.

Chart 3.

Similarly CHART 3 shows the sectors that lag behind in fresh capacity creation.

Upshot

There are two main takeaways from the BoB study.

One, companies saw their profits soar despite stagnant (or contraction) in their net sales. This surge in profits is what is leading to a surge in stock prices.

Two, the corporate performance as well as the boost to private capital formation has been quite uneven — almost in line with the K-shaped consumption recovery.

Three, data also shows that at an aggregate level, Indian Inc. is working at a higher level of capacity utilisation than pre-pandemic. This bodes well for the future.

Until next time,

Udit