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Is India’s Services Growth Engine Slowing?

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India may be set to see its fastest economic growth in three years but a crucial part of the economy is slowing. Services, which still contributes more than half of the gross value added and, in earlier years, were the growth engine for the economy are set to slow in the current year.

Advance estimates for growth put out by the Government’s statistical office earlier this week show that growth across the three key components of the services sector is likely to fall to a seven year low in 2018-19. The reasons, economists say, range from sector specific issues like the slowdown in financial services to tight government finances.

The services sector is estimated to grow at 7.3 percent in the current financial year compared to 7.9 percent last year. While overall GVA growth is expected to recover to 7 percent from 6.5 percent last year, service sector growth will slow.

In calculating services growth, BloombergQuint has included three categories: ‘Financial, Real Estate and Professional Services’, ‘Trade, Hotels and Transport & Communications’ and ‘Public Administration and Defence and Other Services’. Some economists also include construction in the services category while others do not. Including construction, growth in the services segment would be flat compared to last year due to a pick-up in construction activity in 2018-19.

Services, which were a leading engine of India’s growth for long, have been trailing non-services since the past few quarters, becoming a cause of worry, said Dharmakirti Joshi, chief economist at ratings agency, CRISIL.

A break-up of the GVA growth data shows that a slowdown is expected across almost all segments.

Financial, real estate and professional services sector, the largest sub-sector under services, is estimated to grow at 6.8 percent in the current financial year. This is moderately higher than 6.6 percent growth in FY18, but significantly lower than the double digit growth the sector recorded in this segment between FY14 to FY16. Item wise data available until FY17 indicates that growth in financial services declined from 7.5 percent in FY16 to 1.3 percent in FY17. While this fall was led by demonetisation, the sector has continued to face troubles.

“In the current financial year, lack of confidence and NBFC related issues have led to tighter financial conditions impacting financial services,” said Shubhada Rao, chief economist at Yes Bank. “The third quarter, which is usually credit intensive given higher spending on account of the festive season, has instead been subdued.”

Trade, hotels, transport, communication and services related to broadcasting are estimated to grow by 6.9 percent in the current financial year. Item wise data available until FY17 indicates a fall in growth in transportation, communication and broadcasting services.

Intense competition in the telecommunications sector may have had a bearing on this sub-segment of services, said Joshi.

The sector, particularly the trade component, may not have completely recovered from demonetisation and the implementation of GST, added Devendra Pant, chief economist at India ratings. He also attributed the lower growth to the services sector’s dependence on overall demand and sentiment in the economy.

"A marked improvement in services growth is tough as the sector is partly dependent on demand originating from agriculture and manufacturing. " - Devendra Pant, Chief Economist, India Ratings

The government spending driven ‘public administration, defence and other services’ segment is estimated to grow by 8.9 percent in FY19 compared to 10 percent last year. A downward revision in public spending growth is possible going forward as the government attempts to meet it’s fiscal deficit target, Rao said.

Atop sector specific concerns, a broad increase in the cost of services may have also played a role in dampening demand. The introduction of the Goods and Services Tax had pushed services into the 18 percent tax bracket compared to 15 percent earlier, which impacted a range of sectors.

Pratik Jain, partner, indirect tax at PwC explained that real estate had taken a hit after being included in the 18 percent tax bracket as the tax rates prior to GST were in the range of 7-9 percent. Now, the possibility of a reduction in GST rates on sectors such as residential real estate, may improve the sector’s outlook. On Thursday, the GST council said that a group of ministers will be constituted to examine whether a composition scheme can be introduced to boost the residential segment of the real estate sector.

Other services, too, had seen an increase in tax rates but this may not have been substantial enough to subdue demand, Jain said.

. Read more on Business News by BloombergQuint.