Q1 GDP may force rethink on forecasts

But expectations of a soft landing intact

MUMBAI: The surprisingly strong gross domestic product (GDP) has forced economists to revisit their calculations again.

Expectations were that growth would show some signs of moderation because of tough measures by the Reserve Bank of India to control inflation since December last year.

The economy grew by 9.3% in April-June 2007, riding on a strong performance by the manufacturing sector.  The high growth has made economists sit up and take notice. Most of them, who had given low estimates for 2007-08, have now revised or are in the process of revising forecasts upwards.

 "We have tweaked up our real GDP growth estimates to 8.8% (from 8.5%) for FY08, as services continue to be resilient to base effects. This is in line with our soft landing hypothesis in the absence of overheating signs," DSP Merrill Lynch India economist, Indranil Sen Gupta, wrote in a report. Morgan Stanley economists, Chetan Ahya and Tanvee Gupta have also revised their FY 08 forecasts slightly upwards to 7.8% from 7.7% in their August 31 analysis.

"This (Q1 GDP) was ahead of our (8.5%-9%) and consensus expectations (9%), mainly on account of stronger-than-expected growth in the services sector," Ahya and Gupta wrote, noting that domestic demand growth accelerated in Q1 despite tightening measures.

HDFC Bank chief economist Abheek Barua has also hiked his FY08 GDP estimate to 8.6-8.8% from 8.3% following the strong numbers because "after the 9.3% first quarter growth, it would need a significant deceleration of growth to slowdown to 8.3% in FY08."

The first quarter numbers are also higher than Barua's expectations of 9% growth. But higher growth in the first quarter has not changed  expectations of a soft landing for growth in FY08. They  see moderation in growth due to rate hikes and the impact of a rising rupee on exports. "Soft landing means growth will be at a lower pace than last year. It's just like running at a steady pace without worrying about falling down. Instead of growing at 10% with fear that growth could drop to 5%, we can comfortably grow around 8.5% for the next couple of years," said Indranil Sen Gupta of DSP Merrill Lynch.

Soft landing is associated with a slowdown in growth rate. On the other hand, 'over heating' occurs when a country's aggregate production capacity is unable to keep pace with growing demand. Such a kind of 'overheating' is  characterised by high unsustainable growth rates.

Though economists support the soft landing theory, whether the economy is at all overheated is a matter of debatable. There were signs of overheating in some sectors.

Says Abheek Barua from HDFC Bank: "There was overheating in some areas like housing, consumer durables and auto due to easy finance, but the crucial sectors like infrastructure construction, capital goods and investments were not impacted." Economists expect growth to slowdown from 9.4% last year to around 8.5% this year. "It is down from last year but sustainable," said Shuchita Mehta, economist, South Asia, Standard Chartered Bank.

Morgan Stanley is the most bearish on growth with economists Chetan Ahya and Tanvee Gupta expecting a 7.8% growth. Despite the upward revision of forecasts, Morgan Staley is still looking for a slowdown in the second half of 2007. "We believe the rise in lending rates in Dec 2006-March 2007 is likely to be fully reflected with a lag in domestic demand in H2 2007. The appreciation in the rupee since early March will likely result in further slowdown in export growth in the coming months," Ahya and Gupta wrote.