Services industry emerges as a strong performer in GDP growth in Q3 FY14

Divergence between the PMI indices for manufacturing and services, and the actual data (growth rates) and IIP figures will continue since the nature of these indicators is different

The Purchasing Managers’ Index (PMI) for manufacturing in the month of February is at a year high of 52.5 compared with 51 in April ‘13. On the other hand, the GDP estimates released last week suggested that the manufacturing industry slowed down by -1.9% in Q3 FY14 compared with the growth of 2.5% in the corresponding quarter of last fiscal.
Likewise, the PMI services index for the month of February stands at a low of 48.8 maintaining its deterioration for the eighth consecutive month. However, the services industry emerged as one of the strong performers in the recent estimate of GDP growth in Q3 FY14, points out a research note.


Are we today facing severe stagnation or are we facing a contradiction due to the indicators selected for analysis? This is the dilemma for analysts of the Indian economy. According to CARE Ratings, divergence between the PMI indices for manufacturing and services and the actual data (growth rates) released under the GDP estimates and IIP figures will continue since the nature of these indicators is different. The PMI captures in a way the level of confidence or perception based on a comparison over the immediate previous period, while growth rates are over the same period of the previous year thus adjusting to an extent the seasonal component. Each of these concepts has their own uses but the PMI may not be taken to be reflective of the growth in the concerned sector.


Growth in the services sector is high, as revealed in the quarterly estimates of GDP. Please see table below:


According to the research note, the PMI services index has remained below 50 from July 2013 onwards. The index has fallen from 50.7 in April ’13 to 48.8 in February 2014. The index below 50 indicates that the services sector has witnessed negative growth based on the responses by the private companies. Please see chart below:


In contrast, there is stagnation in the manufacturing sector, as can be seen from the charts below:



The sluggish growth in FY14 is a result of weak consumer demand, and low investments partly due to the high interest rates maintained by RBI (Reserve Bank of India) in its bid to fight inflation. Further, manufacturing sector having recorded negative growth for the last three consecutive months vis-à-vis the same time window in FY13 is indicative of the stagnation the manufacturing industry is currently encountering.


Increased lending to consumers amid slowing investment

Higher credit to services and personal loans may partly explain elevated core CPI inflation

Increased lending to consumers (personal loans) amid slowing investment suggests there is a demand slowdown. The RBI (Reserve Bank of India) is trying to orchestrate just this by hiking interest rates (to slow consumption growth and services price inflation). It might however, take much longer than expected, points out Nomura in a research note on bank lending. Hence, higher credit to services and personal loans may partly explain elevated core CPI (consumer price index) inflation.


Credit is one of the most important channels through which monetary policy affects aggregate demand and inflation. Hence, the divergence in the nature of bank lending has important implications including the one above. It could also, partly explain the divergence of manufacturing inflation (core WPI – wholesale price index – about 3% year-on-year) from services price inflation (core CPI – consumer price index - about8%). This is because, although manufacturing growth has tumbled, services demand remains relatively high, fuelled partly by credit, explains Nomura.


Credit growth by sector in the Indian banking system is shown in the chart below:

The research note says that after a sharp slowdown in 2011-12, credit growth has stabilised at around 15% y-o-y in the last year. However, although the headline number is stable, there are sectoral divergences. Specifically, credit growth to industry has steadily moderated, while loans extended to services sectors and personal loans have risen.


Generation efficiency norms in power sector tightened

Following the notification of the CERC FY15-19 regulations relating to the power sector, the generation efficiency norms have been tightened

CERC (Central Electricity Regulatory Commission) has notified the final tariff regulations for FY15-19, which have lowered overall incentives (such as shifting from normative plant availability (PAF) to plant load factor (PLF) for earning incentives, reducing station heat rate (SHR) and auxiliary consumption) for central generation PSUs (public sector undertakings).


However, CERC has provided some relief to CPSU generators in terms of (a)  PAF based recovery of fixed cost cut to 83% (v/s 85% earlier) and (b)  complete pass-through of water charges and capital spares (v/s nil earlier), points out CARE Ratings in a research note.


On the other hand, the regulations reduce overall purchase price for DISCOMs due to (a) tax component on actual (v/s grossing up benefit earlier) and (b) payment of incentives on the basis of demand (rather than availability based payments earlier). Thus, this is estimated to bring in 9-10 paise/kWh relief to DISCOMs, which in-turn should be passed to consumers, says the research note.


CARE Ratings also says that the regulations are marginally negative for central transmission company i.e. Power Grid, where normative PAF levels increased to 98.5% (v/s 98% earlier).


According to the research note, the other key changes include: (a) Land acquisition is treated as ‘controllable’ factor- a big challenge for green field projects (b) Water charges are to be compensated separately (similar treatment as capital spares) in wake of substantial changes by most of the states (c) Special allowance at Rs0.75 million/MW for FY15 scalable @6.35%/annum. (d) 33%-54% hike in compensation allowance for eligible projects (e) Gains from truing-up of controllable factors to be shared between NTPC and beneficiaries at a ratio of 60:40 and (f) Refinancing of loans is termed as controllable factor and benefits are shared between CPSUs and beneficiaries in the ratio 1:2.


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