The largest chunk of the Indian economy enjoys double-digit or close to double-digit annual growth rates. Moreover, while the rest of the economy falters, this part of the economy has remained relatively strong. This resilient segment of our economy is the services sector.
Here are the numbers: according to the Prime Minister’s economic advisory council (EAC), the growth rate of services in the last few years has been 11% in 2005-06, 10.1% in 2006-07, 10.3% in 2007-08, an amazing 10.1% in 2008-09, when the rest of the world tottered in the aftermath of the global financial crisis, 10.1% in 2009-10 and 9.4% in 2010-11. In fact, so strong is the EAC’s faith in the buoyancy of the services sector that it is projecting a growth of 10% for it this fiscal year, regardless of the slowdown in the rest of the economy and irrespective of the Reserve Bank of India’s (RBI) desperate attempts to apply the brakes.
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The chart shows that India is a three-speed economy. The agricultural sector has low rates of growth and wild swings as droughts and floods are a recurring phenomenon. The industrial part of the economy is also volatile, buffeted by high commodity prices and affected by high interest rates that make expansion expensive. And then we have the services sector, growing at very high rates and relatively unaffected by a slowdown.
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There is a catch, of course. The double-digit growth in services is partly because government expenditure is part of services. One reason why the services sector wasn’t affected by the global financial crisis was because “community and personal services”, which include government spending, increased by 12.7% in 2008-09, compared with 6.9% in the previous year. Growth in this segment remained very high in 2009-10 as well. Interestingly, the EAC’s forecast show that higher growth for “community and personal services” is expected this year too, which means the government’s budgetary estimates for a lower fiscal deficit are likely to go for a toss.
Nevertheless, it is also true that apart from the support provided by “community and personal services”, the other parts of the services sector have grown at near double-digit rates. Take the “Trade, hotels, transport, storage and communications” segment. Apart from 2008-09, when the post-Lehman panic pulled it down to a comparatively tepid growth rate of 7.5%, growth has been very strong. Its worst showing was in Q3 of 2008-09 and in Q1 of 2009-10, when growth slumped to 5.4%. But compare that to the manufacturing sector’s low of 1.3% growth in Q4 of 2008-09. Here are the annual growth rates of the ‘Trade, hotels, transport, storage and communications” segment: 2005-06 12.2%, 2006-07 11.6%, 2007-08 11%, 2009-10 9.7% and 2010-11 10.3%. The EAC forecasts that this segment will grow even more strongly at 10.8% this fiscal year, higher than last year.
The other component of the services sector—“Finance, insurance, real estate and business services”—proved to be even more resilient during the financial crisis, growing by an extraordinary 12.5% in 2008-09 and stopping to catch its breath by reducing speed to 9.2% in 2009-10. Its nadir was in Q4 of 2009-10, when growth fell to 6.3%. The EAC expects this segment to grow by 9.8% this fiscal, a tad below the 9.9% rate it notched up in 2010-11.
Is the EAC right to be so optimistic about the services sector? The track record supports the view about the sector’s resilience. But there’s another, more recent, indication that the sector continues to grow strongly. The HSBC Purchasing Managers’ Index for the services sector is showing no signs of a slowdown. The services PMI accelerated from 55 in May to 56.1 in June and to 58.2 in July, a bit higher than the long-term average. Even the New Business sub-index, an indicator of future growth, accelerated sharply in July compared with the previous two months. So much for RBI’s tightening.
The big question is whether this rate of growth of the services sector sustainable. Gaurav Kapur, senior economist with Royal Bank of Scotland, Mumbai, says that services sector growth lags that of the manufacturing sector, in the sense that it too will slow, but with a lag.
The more important point, though, is: Won’t RBI step on the brakes if the services sector refuses to slow? There is no reason why it shouldn’t, since it aims is to reduce demand and the services sector constitutes the largest chunk of the economy. True, most of RBI’s price forecasts and targets are of the wholesale price index, which doesn’t include the price of services, but it certainly looks at the consumer price indices as well. There’s all the more reason for RBI to continue to raise rates, because both input and output prices in the services sector grew strongly in July, according to the PMI numbers.
The EAC may, therefore, be wrong in relying on the services sector to boost the economy this fiscal. A slowdown in gross domestic product growth from 8.5% in 2010-11 to 8.2% in 2010-11 is unlikely to tame inflation. With RBI in aggressive mode, a far stronger slowdown seems to be on the cards.
Graphic by Yogesh Kumar/Mint
Manas Chakravarty looks at trends and issues in the financial markets. Comment at firstname.lastname@example.org