Can service sector bring back life in Indian office market?

September 19, 2012 / By  

Recently, the annual GDP number (6.5% GDP growth during FY April 2011-March 2012) released by the Reserve Bank of India resulted in a negative sentiment throughout the real estate industry. Consistent with this, in 1H12, the demand for commercial real estate moderated on the back of office occupiers that remained cautious about their expansion plans. However, as the economy’s service sector has still experienced strong growth, advancing at a rate of 8.5% in FY12, a major slowdown in office real estate demand is not likely to occur. This is because the service sector has the highest demand for office space in the country.

Over the years, the service sector has been the growth engine of the Indian economy, and its growth rate has outperformed the overall growth rate of the country’s GDP, which includes the service, agricultural and industrial sectors, the three major sectors of the economy.

The service sector is comprised of the banking, financial services and insurance (BFSI), information technology, consulting, trade and communication industries, which are the major drivers of demand for commercial real estate in the country. The sector has also been one of the country’s core sectors over the past decade, as its contribution to GDP has significantly increased from 50% in FY96 to 63% in FY12. In FY12, when all other sectors, including the industrial and agricultural sectors, performed very poorly at an average of 3.1%, the service sector recorded a healthy growth rate of 8.5%.

Overall GDP and Service sector growth of India

Source: Reserve Bank of India
Note: Overall GDP growth is the average growth of all sectors of the economy including service sector as a component.
FY06 indicates financial year that starts on April 2005 and ends on March 2006.

It is estimated that in 2011, the service sector accounted for about 70% of the demand for commercial office space in seven major Indian cities namely Mumbai, NCR-Delhi, Bangalore, Chennai, Hyderabad, Pune and Kolkata with the remaining 30% coming from manufacturing and other industries. In the service sector, the IT/ITeS and BFSI industries contributed the most, at 35% and 16% respectively. Over the years, consulting services have shown strong demand for office space, which has grown from nearly 3.8% of total demand in 2009 to 13% in 2011. Therefore, the growth of commercial real estate demand depends principally on the growth of the service sector.

The slowdown in GDP growth in FY12 can mainly be attributed to high interest rates, inflation and a significant contraction in industrial production. However, the growth in the service industry, at 8.5%, has been robust enough to support overall GDP and the sector itself. The IT-ITeS sector, which is one of the major constituents of the service industry, recorded a growth rate of 13% in FY12, and the sector is expected to grow at a similar rate during the next financial year. Additionally, BFSI industries registered a robust growth rate of 10% in FY12. Although the manufacturing and industrial sector is performing poorly now, the healthy service sector is likely to compensate for it by contributing a larger share.

The Reserve Bank of India projected that the Indian economy would grow at 6.5% in FY13. As compared to many major world economies, this growth rate is fairly healthy; in addition an established service sector should help India resist any slowdown in office real estate demand.

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