2QFY11 GDP: ‘Services’ wins the match.: Kotak Sec

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Economy
National Accounts
2QFY11 GDP: ‘Services’ wins the match. GDP growth at 8.9% surprised the markets
on the upside. Services sector came up trumps at 9.7% with construction at a very
robust 8.8% and pushed the overall growth much higher than expected. Agriculture
growth was strong at 4.4%. While overall growth from the industry side was at 8.9%
(our estimates at 8.7%), the services sector surprised significantly on the higher side.
While we tweak up our GDP expectation for the year to 8.6% (8.4% earlier) on
account of the very firm services sector trend, directionally we still expect GDP to
moderate in FY2012E.

Agricultural sector strong as expected; services sector outperforms
We had expected a strong show from the agricultural and services sectors and were slightly
bearish on the industrial sector (see Exhibit 1 for details). Mining and quarrying sector was much
stronger which is definitely surprising since the second quarter is usually a weaker quarter owing
to the monsoons. For instance, coal mining in this quarter grew by around 1.5%, much lower than
the 9.7% last year for the same period. But overall the industries sector was in line with what we
had expected. Agricultural growth was strong as expected owing to robust sowing and also due to
some base effects. The big surprise, in our view, was from the services sector which was much
higher than what we (as also consensus) had expected. The robustness was across the board with
the construction sector showing significant strength. Cement production data (from the IIP core
industries data), if taken as a proxy for the construction sector, fail to support this strong showing
by the construction sector.

Output growth from the demand side shows the underlying strength in the economy
GDP at market prices indicated that the underlying demand in the economy remained quite
strong. Private consumption at 9.3% (6.7% a year ago) signals that the domestic demand has
improved significantly. We had highlighted the same in our GDP preview note (‘2QFY11E GDP
preview: Output on a path of moderation’) with reference to taxes, imports and corporate
earnings. Investment scenario has also improved markedly as growth in 2QFY11 picked up to 11%
from 4% a year ago though it fell from the 19% registered in 1QFY11 (revised up significantly
from the earlier official estimate of 7.6%). Overall growth from the expenditure side came in at
10.6%, marginally up from 10.3% of the previous quarter.

We nudge up our annual estimates; momentum in the services sector to continue
In view of the stronger-than-expected growth momentum in the services sector and incorporating
the upward revisions of the previous quarters, we tweak up our forecasts for the current year. For
FY2011E we expect growth rate at 8.6% (earlier 8.4%) and for FY2012E at 8.1% (earlier 7.8%)
(see Exhibit 1). These revisions are based on the momentum shown in 2QFY11 and in no way
alters our directional view for the economy. For 3QFY11E we expect growth rate to be >8.5% but
expect it to slow to <8.0% in 4QFY11E, based on our expectation of a cyclical slowdown in the
industrial segment mainly.

RBI unlikely to be influenced; expect a temporary pause in the December meeting
From a monetary policy perspective, we do not expect any change in RBI’s stance as a result of this
robust GDP number. We continue to expect the December meeting to be a non-event and expect
an action only at the January 25 meeting. With headroom created by the strong growth rate, we
reiterate our call for an additional 25 bps hike till end-FY2011E with a temporary breather in
December. The continuing tight liquidity conditions will lead to the Repo Rate continuing to be the
operative rate.