India’s economy is buzzing but weaker exports could be a drag

India’s economic activity picked up pace in April on record tax collections and a booming services sector though rising unemployment and weaker trade metrics could sap some sentiment.

The needle on a dial measuring the so-called Animal Spirits swung to six after staying at five for three consecutive months, signaling some strengthening in Asia’s third-largest economy. While six of the eight high-frequency indicators compiled by Bloomberg showed an improvement, a slowdown in India’s key export markets and high jobless rate may cloud prospects.

The reading comes ahead of the Reserve Bank of India’s monetary policy decision due June 8, where it is likely to stay on hold as central bankers assess the impact of past year’s rate hikes on growth and inflation. Positive economic indicators would give comfort to the rate setters that an aggressive tightening hasn’t choked up the economy, allowing borrowing costs to remain elevated for longer to keep inflation within the target range of 2%-6%. Retail inflation slowed to an 18-month low of 4.70% in April.

Here are more details from the animal spirits barometer, which uses a three-month weighted average to smooth out volatility in single-month readings:

Business Activity
Purchasing managers’ surveys showed manufacturing activity improving as raw material costs moderated, leading to “unprecedented increase in input stocks as manufacturers seek to fulfill demand,” according to S&P Global Inc. Services activity and new business rose at fastest pace since June 2010, pushing up the composite index to a new high of 61.60.

Stronger demand conditions allowed businesses to pass on rising costs to customers and to pay higher wages to staff though the labor market remained weak. “Despite the substantial pick-up in sales growth and improved business sentiment toward the outlook, the increase in employment seen in April was negligible and failed to gain meaningful traction,” said Pollyanna De Lima, economics associate director at S&P Global Market Intelligence.

Exports
India’s trade outlook is dimming both at home and abroad. Exports dropped 12.7% in April, while imports declined 14.06% from a year ago, narrowing the trade gap to near two-year low. Demand for Indian goods in the US and Europe is “not looking good” and it may stay the same for the next two to three months, Director General of Foreign Trade Santosh Kumar Sarangi said last week.

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In contrast, the services sector saw outbound shipments rising for a second month, aided by a surge in information technology and business consulting work for India, known as the back office of the world.

Market share gains helped to propel India’s services exports to $33 billion and it “would still stay stable at a high level even if global services do not grow from here,” Morgan Stanley economists led by Chetan Ahya said in a research note May 17.

Consumer Activity
Liquidity in the banking system tightened in April, pushing up overnight rates and making it difficult for firms with a weaker credit profile to access funds from the markets. However, overall bank credit still increased from a month ago as companies borrowed to expand operations and meet domestic demand.

Banking system liquidity is set to improve in the coming weeks after the central bank removed the highest valued bank notes from circulation, which may spur more deposits.

India’s goods and services tax collection, which helps measure consumption, hit a record high of 1.87 trillion rupees ($22.6 billion) in April after rising 12% from a year ago. In a sign that the growth in consumer demand is uneven, new vehicle retail sales fell 1.4% in the same period, according to data from the Federation of Automobile Dealers Associations.

Market Sentiment
Electricity consumption, a widely used proxy to measure demand in industrial and manufacturing sectors, rose from the previous month with the onset of the summer season. Peak demand at the end of April rose to 178 gigawatt from 170 gigawatt a month ago.

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India’s unemployment rate climbed to four-month high of 8.11%, from 7.80% in March as job creation failed to keep pace with a rapidly growing workforce in the world’s most populous country.