Hotels, airlines, restaurants are full: Services could cushion the blow to GDP

A trip to the mall can be a broad pointer to how the economy is faring on some fronts. Last week, a visit to a luxury mall in central Mumbai turned out to be quite so for me. Reaching a bit late for lunch, my wife and I had to take a tour of quite a few restaurants at the food court before we finally got a table at one. All restaurants, no matter what the cuisine, were full up, we were told, and the waiting time was not less than 30 minutes anywhere. Elsewhere at the mall, people were constantly coming in and high-end stores which, till some time ago, were empty were now busy serving customers—from watches to shoes to clothing brands, customers were present in nearly all the stores. 
A few days ago, the CEO of a large hotels chain I was meeting at his central Mumbai property told me he had trouble finding a room in his own hotel since it was full. He managed to find a room after much effort and the hotel was witnessing soaring occupancy levels. Ditto is the case in the airlines sector where flights are once again running to full capacity. 

It is indeed the return of the services sector. Following the lower COVID-19 numbers and the opening up of the economy, the services sector is witnessing a strong revival. Not surprising, the S&P Global India Services PMI—a leading indicator—jumped to a five-month high of 57.9 in April, up from the March print of 53.6, demonstrating strong upturn in the services sector. A figure above 50 in the PMI shows expansion. 

This upturn is despite price pressures and mounting inflation. Services accounts for 54 per cent of the gross value added in the Indian economy, and hence this revival has expectedly caused some cheer amidst the gloom and doom all around thanks to soaring inflation, geopolitical risks and crashing markets.

But can this buoyancy in services be sustained? And can it cushion the blow to growth in the wake of rising interest rates following the higher inflation numbers? That is the real challenge which economists are now worried about. Rahul Bajoria, Chief Economist at Barclays, points this out in a report when he says the services PMI reaching a five-month high is indication that services activity has returned to pre-Omicron levels. However, he sounds a warning, saying “downside risks to activity remain from rising inflation, but activity is showing resiliency.”

Bajoria is of the opinion that despite higher transport and input costs, the services sector posted better numbers amid ongoing gains seen in high-contact services sector, and also in new business orders. “Input costs continue to spike, hitting the highest levels seen in the sub-index since June 2008. However, this momentum was not reflected fully in output prices for services, which although while rising, remain well below the input cost index.” So, for now, the services sector may be absorbing the inflationary pressures well and, consequently, generating good numbers. 

Just as the PMI print gave some relief to policymakers came the April consumer price inflation—CPI—figure at an elevated 7.8 per cent, a nearly 8-year high and well above the Reserve Bank of India’s (RBI) tolerance level of 6 per cent. With RBI already having stunned the market on May 4, delivering a sudden 40 basis point (bps) repo rate hike together with a 50 bps hike in the cash reserve ratio, there’s every possibility now that the June policy statement from the central bank will deliver another rate hike, with some betting on a 25-35 bps in June. Overall, for FY23, the bets are on further rate hikes of anywhere between 75 to 100 bps, since inflation has clearly become a huge worry for the central bank.

Despite the bullish services scenario, Bank of Baroda Chief Economist Madan Sabnavis admits that inflation will come back to bite the sector at some point. Sabnavis tells me that services, for now, has not been impacted by the Ukraine crisis and the domestic market has been providing enough opportunity for a services boost. While the food and beverages sector is benefitting from pent-up demand, tourism is seeing a surge as the holiday season begins (leading also to the hotels sector gaining), but inflation could start hitting home soon. “If a family is eating out ten times a month, they may first reduce it to eight times and then to five times,” Sabnavis reasons. He says with schools and colleges reopening, education is seeing a rebound, and healthcare is also a sector which will be doing well despite price increases since these are necessities. But discretionary spends will be bound to take a hit over time. It must also be remembered that as inflation has been rising, prices of manufactured goods such as personal care, and household goods have gone up as producers have passed on their input costs. Sabnavis points out that these prices are unlikely to come down as once the MRP goes up there are few chances of being reduced even as commodity input costs come down. That stickiness will further add to pressures on the services front.

As the rate hikes start impacting the growth momentum, there’s also a good chance that corporates which were planning to resume capital expenditure owing to the turnaround in demand would once again hold off on committing investments. As the cost of money increases, companies will be waiting to watch the impact on demand before installing fresh capacities. In such a scenario, the rebound in the services sector will be keenly watched by the corporate sector. How long the services sector can propel the growth momentum in the wake of the cocktail of uncertainties the Indian economy faces will hold the key to the final GDP numbers we end up with this year. 

But for now, it appears to be party time at the malls.

The author is Editor, Business Today.