Domestic consumption demand has always been the mainstay of the Indian economy. In recent years, however, its importance has been slowly diminishing, with the slack being taken over by capital expenditure. Private final consumption expenditure (PFCE, the main measure of domestic demand in the economy), which formed 60.3% of the gross domestic product (GDP) at market prices in 2004-05, now accounts for only 57.2%. The slack has been taken up by gross fixed capital formation (GFCF, the money spent on adding to the nation’s stock of capital, such as new factories, new machinery, new buildings). GFCF accounted for 27.9% of GDP at market prices in FY07, up from 25.3% in 2004-05.
In fact, of the growth in GDP during FY07, GFCF contributed Rs1,10,812 crore, more than the Rs1,03,672 crore contributed by PFCE. In FY07, capital expenditure replaced private consumption expenditure as the driver of GDP growth. That’s not surprising, considering that India Inc. has started increasing capacity and that the government has stepped up its investments in infrastructure.
The slowdown in PFCE growth is an indicator that higher interest rates are having an impact, a conclusion buttressed by the clear signs of a slowdown in retail credit and in sectors such as two-wheelers. PFCE growth was 6.2% in FY07, below FY06’s rate of 6.7%. The March quarter shows a further deceleration to 5.9%, compared with the year-ago period.
The slowdown is even clearer if we compare the year-on-year growth in the two halves of FY07. While PFCE growth was 6.4% in the first half, it fell to 5.9% in the second. In contrast, growth in capital expenditure was 14.7% in the second half of FY07. As Rob Subbaraman, senior vice-president and chief economist (Asia), Lehman Brothers, puts it, “Going forward, the sharp rise in capital goods imports and surging FDI (foreign direct investment) inflows indicate that investment is likely to remain the key growth driver.”
The key question for the markets is whether the 9.1% GDP growth rate in the March quarter will lead to more tightening by the Reserve Bank of India (RBI).
As the data shows, consumption growth has started to slow. Recent RBI numbers show that bank lending too is slowing. Additional capacity coming on stream will ease the pressure on prices. But while higher interest rates may have started to have an effect, the central bank may prefer to err on the side of caution.
RBI may also be forced to tighten if it buys dollars to prevent further appreciation of the rupee and has to mop up the resulting liquidity.
But the stock market showed no signs it was worried, with the interest-rate sensitive indices such as the BSE Bankex and BSE Auto both gaining 1.3% on Thursday.
The yield on the benchmark 10-year bond barely moved.
The stocks of Apollo Hospitals and Fortis Healthcare moved briefly in opposite directions as news broke of Dr Trehan’s move to Apollo, with several doctors likely to follow him. Apart from that, however, the Fortis stock has slowly been drifting down ever since its listing and Trehan’s exit is merely the latest blow. The market for doctors is highly competitive and attracting and retaining them is one of the key challenges.
But even the Apollo Hospitals stock has been a severe underperformer and it hasn’t moved at all since end-February. That seems strange, given that Apollo is in a sector with high entry barriers, is a play on the middle class’ increasing ability to pay for high-class medical services and seems to have got its act right. The problem seems to be twofold. One, it has an aggressive expansion plan that will increase interest and depreciation costs. More importantly, however, the trouble is that at a consensus EPS (earnings per share) of around 16.5 for FY08, the stock at around Rs500 continues to look expensive.
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