Should you trust India's new GDP number?

Feb 10, 2015

In this issue:
» The problem of double-digit inflation
» Crude could go as low as US$ 20
» Risks abound for the global economy
» ...and more!

We had written in one of our earlier editions of the 5 Minute Wrapup on how the World Bank and the IMF have predicted India's GDP growth to surpass that of China by 2016/17. Indeed, this was all the more so considering that China had posted its weakest annual growth in 24 years at 7.4% in 2014.

Now it appears that India could pip China sooner than you think. As has been reported in various business dailies, India is expected to post a GDP growth of 7.4% in FY15. But here's the catch and a big one at that. The rosy GDP growth projection is more a product of revision in the way GDP is calculated. For starters, the base year has been changed from 2004-05 to 2011-12. Secondly, the growth number will be based on GDP at market prices rather than at factor cost. The idea is to make India's growth rates comparable internationally. Thirdly, the statistics office has also expanded its coverage of manufacturing and included under-represented sectors and data from the corporate database of the government.

So, is this higher rate of GDP growth something to be excited about? The problem is that the ground reality appears to be quite different. On a broader basis, there has not been a considerable pick up in investments, not many fresh projects have been undertaken and rise in consumer demand has been gradual. In light of this, the GDP growth of 7.4% seems too optimistic.

But there is more. One measure of a pickup in economic activity is the growth in bank credit. And this so far presents a contrasting picture. Indeed, as reported in an article in Firstpost, bank lending to industry has grown by just 2.1% for the fiscal year till December as compared with 8.1% in the corresponding period in last year. And this has been across sectors barring a couple such as construction and beverages & tobacco.

The other anomaly is the index of industrial production (IIP) data. This is expected to come in at around 2-3% for FY15. However, the new GDP methodology expects manufacturing to report a growth of 6.8%. Even if the method of calculation for both is different, the divergence between the two numbers is still too wide.

It is not that there is no pickup in growth at all. For instance, in our interaction with some leading auto companies, there has been a rise in volumes of medium and heavy commercial vehicles (MHCVs) and firm freight rates have been one of the reasons for this. Mining operations also have gradually resumed. But if the results of companies are anything to go by, demand has been slow and a strong pickup in growth has yet to take place. Infact, a leading engineering company has stated that while the domestic sentiment has improved, investment momentum has yet to pick up pace. In other words, the recovery so far has been gradual and so in that context, the GDP growth of 7.4% for FY15 does seem a bit too rosy.

All these factors lead us to believe that at present, investors should take this new GDP number with a pinch of salt until more clarity emerges on the same. The real test of whether growth in the country is improving will depend on how effectively the Modi government is able to implement policies that will encourage investments into the country.

That is why investors must not get carried away by these higher GDP numbers and base their investment decisions solely on them. Is this GDP growth translating into higher earnings for companies? And are the valuations attractive enough? These are some of the questions that investors need to consider before they choose to invest in any stock.

Do you believe that there is a stark difference between the new GDP number and the ground reality? Let us know your comments or share your views in the Equitymaster Club.

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  Chart of the day
If the chart is any indication, double-digit inflation is turning out to be a huge problem for countries such as Russia, Venezuela, Ukraine and the like. Russia for instance has been hit hard by falling crude prices, sanctions and a plunging ruble. Venezuela is also grappling with the dramatic drop in oil prices. However, the prices of food and other items have increased and have pushed up overall inflation as a result as shortages persist. Not a while ago, India was in a similar situation. Inflation was quite high and GDP growth had slowed down. However, the RBI was clear in its objective of easing off inflation and so kept the interest rates firm even in an environment of slowing growth. This trend has now begun to reverse. How will Russia and Venezuela then tackle this problem? One will have to wait and see.

The problem of double-digit inflation

As you know, the most surprising and unexpected turn of events have played out over the last few months as far as the price of crude oil is concerned. And economist and market commentators now seem to have woken up to the fact that it might not be such a good idea after all to have the current price of oil as their anchor while forecasting its future prices. Forecasts are getting much bolder as a consequence.

Take Citigroup for example. In a report yesterday, it lowered its forecast for crude to as low as US$ 20! It cites the fact that oil production in the US is still rising, and Brazil and Russia too are pumping oil at record levels. Large OPEC members like Saudi Arabia, Iraq and Iran are still fighting to maintain their market share by cutting prices. More so, amidst this oversupply, storage tanks seem to be topping out. It is in this backdrop that it forecasts West Texas Intermediate (WTI) Crude, which currently trades at about US$ 52 per barrel, falling to as low as US$ 20. If this happens, it would take crude even lower than the lows it hit during the dark days of the credit crisis.

For now, it does look like the US shale oil revolution has swept the carpet from under OPEC's feet. For decades, OPEC's cartel like power has been strong enough for it to be able to manipulate global oil prices in its favour. But if oil prices continue their freefall, analysts now question whether OPEC will ever be able to return to its old way of doing business. Interesting times ahead indeed.

The changing times are hardly going unnoticed by wise investors. Renowned investor and founder of the Vanguard Group, Jack Bogle, is a worried man these days. In a recent interview, he was quick to point out that 'we live in a very uncertain and fragile world with big risks'. Which would still be okay, save for the fact that in the stock market, it is bullishness that now prevails. And this applies as much to the Indian markets as to the US market, both of which seem to have little concern for the potential risks that are lurking around the corners.

In fact, Bogle highlights how financial risks and economic risks are not the only risks that face the global economy these days. Even the risk of war is rising all over the world. With stock market valuations barely pricing in few risks, any of these coming to the fore could very well mean a large and sudden drop in stock prices. Needless to say, it remains crucial for investors to always consider not only the rewards, but also the risks while investing in the stock markets.

The Indian stock markets were trading strong today on the back of sustained buying activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 175 points. Gains were largely seen in banking and auto stocks.

 Today's investing mantra
"You want to see, first, that sales and earnings per share are moving forward at an acceptable rate and, second, that you can buy the stock at a reasonable price." - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Radhika Pandit.

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