Why is the growth subdued in the services sector?

The seasonally adjusted S&P Global India Services PMI Business Activity Index fell to 54.3 in September from 57.2 in August. A reading above 50 indicates expansion. Though in expansion mode, the latest services PMI print highlighted the weakest rate of expansion since March. In comparison, the headline manufacturing PMI, fell to a three month-low of 55.1 in September.

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“The moderation was more marked than we expected and was broad-based in nature," said Miguel Chanco, chief emerging Asia economist at Pantheon Macroeconomics. Similar to the headline services PMI index, the New Orders Index rose at the slowest pace since March. The index measuring employment remained above the crucial 50-mark for the fourth consecutive month in September. However, that doesn’t mean the outlook is bright on this front. “Elsewhere, the punchy spike in headcounts moderated substantially too, with this gauge dropping to 52.5, after spiking to a multi-year high of 54.4 in the previous month, seemingly out of nowhere," Chanco said. In the short-run the demand for labour is likely to soften, given that the index measuring backlogs of work is slowing sharply, he cautioned.

What’s more, input costs have eased for both manufacturers and service providers but the latter are finding it difficult to increase price sufficiently. As per the PMI report, though selling prices once again rose at an above-trend pace, the overall rate of inflation fell to a six-month low in September.

“The gap between input and output prices is narrowing for manufacturers, but in the case of services providers, that gap has opened up again. This reflects that business growth in the services sector, which was driven by pent-up demand, is waning in a run-up to the festive season," said Rahul Bajoria, chief India economist at Barclays. In short, service providers are losing price competitiveness and that should keep their margins under pressure, he said.

Little wonder then that the relatively subdued performance of the services sector weighed on the S&P Global India Composite PMI Output Index, which slipped to 55.1 in September from 58.2 in the previous month. The Composite Output Index is a weighted average of the Manufacturing Output Index and the Services Business Activity Index.

However, despite these factors, Indian service providers remain bullish about the future. Marketing efforts and forecasts of sales growth boosted business confidence in September, said the PMI survey report. Services firms were at their most upbeat towards the outlook in more than seven-and-a-half years, it said. Indian manufacturers were equally optimistic in September, pushing the Future Output Index to a multi-year high. India’s Composite Future Output Index at 64.2 was higher than the global reading of 61.7.

Investors should, however, not get carried away by this. There are slew of factors playing out simultaneously and are feared to further derail business growth momentum in both these sectors. These include the depreciation of the rupee against the US dollar, rising interest rates in India and worldwide, and a threat of a global economic recession. Going by recent PMI surveys, cost inflation has peaked out.

However, India’s inflation measured via the consumer price index rose to 7% in August, above the Reserve Bank of India’s comfort zone of 6%. One fallout of elevated inflation is feared to be felt on consumers’ purchasing power, especially for discretionary items, thus hurting business sentiments.

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