India’s services take a hit

India’s service sector reportedly took a hit in February, as PMI fell to 47.8. This contraction is a six-month low for the industry. The industry was adversely affected by the imposition of a Gross Service Tax hike in July last year.

Background

India is the world's seventh-largest economy by nominal Gross Domestic Product. It is also the third largest economy in terms of Purchasing Power Parity (PPP). However, it ranks at 141 in per capita GDP (nominal).

The Indian economy is considered to have enormous potential for long-term growth due to its high youth population, healthy savings and investment rates, and increasing integration into the global economy. India has an enormous labour force of approximately 521.9 billion, with a majority employed in the agricultural sector.

In 2017, the growth of the Indian economy slowed down considerably. Between the months of April and June, it grew by 5.7%, which was a three year low. However, between October-December 2017, the GDP grew by 7.2%, higher than the predicted rate of 7%. The Indian Statistics Ministry has predicted a growth of 6.6% for March 2018, and the IMF has retained its high growth forecast of 7.4% for the Indian GDP in 2018.

The Indian service sector takes up a dominant share of the country’s GDP. Aviation, retail, and banking and finance are some key areas. IT, BPO, and software services constitute rapidly-growing areas of the economy. In 2014, it was announced that India has the second fastest growing services sector with a compound annual growth rate of approximately 9%. Between 2016-2017, the service sector attracted over 60% of foreign investment, employed approximately 28% of the population, and contributed 53.8% of its Gross Value Added (GVA).

Analysis

Services have long been touted as the fastest growing sector of the Indian economy. However, on the 5^th of March, reports emerged that India’s service industry contracted in the month of February. The industry had previously hit a low in 2016, after the initiation of a demonetization policy and a ban on high value currency notes. The imposition of a national Goods and Services Tax (GST) in the latter half of 2017 also increased prices and weakened demand.

The Nikkei/IHS Markit Services Purchasing Managers’ Index (PMI) fell to 47.8 in February, from 51.7 in January. This total is a six-month low. A score below 50 indicates contraction, while a score above 50 indicates growth. The private survey determines expansion and contraction by tracking new businesses.

“Both activity and new work declined for the first time since November, with rates of contraction the strongest since August, thereby ending the recent recovery experienced by India’s service sector,” said Aashna Dodhia, Economist at IHS Markit. “Anecdotal evidence pointed to weak underlying demand conditions in the service economy.”

“However, (services) firms seem to believe that the decline is transitory as they raised their staffing levels at the joint-fastest pace since June 2011, in line with positive projections of activity growth,” she added.

The manufacturing industry also showed slower expansion in February, with lower output and new-order growth rates. Dodhia commented, “It was promising to see that India’s manufacturing sector remained in growth territory, as the impact of July’s Goods and Services Tax continues to dissipate.”

As a result, composite PMI fell from 52.5 in January to 49.7 last month. Inflation has continued to rise due to increased input costs and high fuel prices. Analysts have noted that the expansive 2018 union budget, announced last month, also contributes to inflation due to broader fiscal deficit goals.

Inflation was 5.07% in January, higher than the Reserve Bank of India’s (RBI) target of 4% for the medium term. Madan Sabnavis, economist at Care Ratings Ltd told Bloomberg, “RBI is focused on inflation. They have a target and as long as inflation is in higher trajectory there’s no case for RBI to lower rates.”

Assessment

Our assessment is that the Reserve Bank’s rate setting stance may determine the service industry’s performance next month. The government’s ambitious budget for 2018 has resulted in concerns about sustained inflation. Increased prices due to the GST hike have also continued to impact the sector.