However, the good news ends there. While private demand slowed down as expected, the major cause for concern remains drastic slowdown in investment. The Gross Fixed Capital Formation (GFCF) grew by a mere 0.7% y/y as compared to 14.7% y/y growth recorded during Q1FY12. In fact, over the last four quarters GFCF growth averaged only 2.26% y/y, clearly hinting at the supply side constraint faced by the economy. The economy has also been dealt a severe blow by various corruption cases that have been unearthed in the mining sector with regard to allocation, land acquisition, environmental issues etc. As a result, the mining sector remained stagnant (growing by 0.1% y/y), that too after contracting during the same period in the previous year (-0.2% y/y). The demand destruction that we have seen over the period coupled with high inflation and interest rate meant the manufacturing has stagnated. In fact, this sector seems to have has fallen off the cliff what with Q1FY13 growth of only 0.2% y/y, and an average growth of 0.86% y/y over the last four quarters. This has impacted the service sector growth rate as well. With a growth of 7.4% y/y during Q1FY13, the service sector recorded the 5th continuous quarter of lower growth rate.
The Q1 growth has been buoyed by two major factors –10.8% y/y growth in construction and a 7.9% y/y growth in social sector spending. While delayed rainfall would have buoyed construction activity, high social sector spending comes at a cost of deficit and inflation. During Q1FY13, India’s fiscal deficit was nearly 40% of what was budgeted and, for the full year, the deficit is likely to be in the range of 5.5-6.0% of GDP vis-a-vis budgeted expectation of 5.1%. What further add to the problem is continued deadlock in the parliament caused by the BJP on the basis of the CAG report on coal allocation as this reduces the possible window of enactment of some economy friendly decisions. This coupled with low growth and high deficit may engender sovereign rating downgrade for India.
With domestic consumption faltering, I expect increased spending by the government to continue to prop up the economy. I believe that higher capital spending by the government is likely to kick in by the third quarter of the fiscal year, which is the first year of the 12th Five year Plan. On the positive side, monsoon is showing signs of recovery, which would likely reduce the quantum of crop loss during the Kharif (summer or monsoon) crop season.
On the policy front, I do not expect any rate action by the RBI (atleast till December 2012) given that both fiscal deficit and inflation is expected to remain high.