GDP – new speedometer, same engine

Statements like “India becoming the fastest growing major economy” and “overtaking China for the first time” have been celebrated with much fanfare in recent times. Not a week goes by, when the Indian PM fails to tweet some article or the other about it . The numerous propaganda pages of the BJP have been doing much chest-thumping over this on social media for a while now.

Statistical figures such as GDP growth rates are like speedometers of a car. Unless there has been a massive overhaul of the Maruti 800 engine itself, there is no wisdom in jumping with joy by just looking at a badly calibrated Ferrari speedometer installed on it.

Has there indeed been a remarkable structural change in the economy in the recent times? Or is this change in GDP figures mainly coming from re-interpretation of data in a different way?

The new Speedometer

India’s Central Statistical Office (CSO) adapted a new method to calculated GDP recently.

The older method had definitely underestimated our GDP growth all these years.

In theory, the new method should make our numbers in line with the UN-IMF system used by rest of the world. It tries to capture the costs at consumption, tries to include many “qualitative” factors that were not captured earlier, and should measure the economic output better.

However, some of these “qualitative” factors also introduce an element of subjectivity. For example, there was a very large difference (40-100%) between estimates of 2 versions of this CSO drafts with the new methodology itself.[1]

So, what caused this difference, especially in the estimates of the corporate sector output? According to Ashish Kumar, Director General, CSO

“The estimates of the original sub-committee report were based on the MCA-21 database but the revised estimates were generated by blowing up these estimates on the basis of the paid-up capital of all the active registered companies”

Estimation of corporate data

In the earlier GDP series, the estimates for the private corporate sector were based on a sample survey of companies conducted by RBI. This sample consisted of only a few thousand companies, and hence the estimates were blown up (or multiplied) in proportion to the coverage of the paid up capital of the sample companies to the total number of companies registered with the Ministry of Company Affairs (MCA).

Subsequently, MCA tightened norms on filing returns and initiated e-filing of company returns which had led to an improved database of companies, the MCA-21 database. Given the limitations of the earlier data, the sub-committee on private corporate data revisions suggested that the MCA-21 database be used to generate national account estimates relating to the private corporate sector, since that database included the returns of all working companies.The estimates generated were lower than those arrived at by blowing the RBI sample. But the fresh estimates were accepted since they were deemed more reliable, and the problems with blowing up the RBI sample were widely acknowledged.

However, after the sub-committee finalized its report, the advisory committee suggested a change in methodology. It suggested that the MCA-21 based estimates be blown up again, in proportion to the coverage of the paid-up capital of the companies in the database in the total universe of ‘active’ registered companies. ‘Active’ companies were defined as those that filed returns at least once in the past three years. ‘Active’ companies number nearly 900,000 while the MCA-21 database includes data on 520,000 companies, which account for 85% of the paid-up capital of the universe of ‘active’ companies. The new estimates arrived at blowing up the MCA-21 database were significantly higher than those obtained by blowing up the RBI sample estimates.

How is GDP Calculated?

For most sectors, the statistics agency starts off by calculating “Gross Value Added” (GVA), a measure of economic growth, in nominal terms. Put simply:

GVA = Economic output – Input

The GDP is estimated from the supply side by aggregating the value added in different sectors such as agriculture, manufacturing, electricity and construction.

Supply Side GDP = GVA + Producer Taxes – Producer Subsidies

It is also estimated from the demand side by aggregating private consumption (C), government consumption (G), total investment (I) and exports (X) and subtracting imports (M).

Demand Side estimate of GDP= C+G + I +(X-M)

The difference between the two estimates is shown as a statistical discrepancy. Mathematically these can be represented as,

Discrepancy = GDP (demand side) – GDP (supply side)

Recently, when Q4 2016 data was released, it turned out that Discrepancy was the second largest contributor to GDP growth! In 2015-16, the real GDP as measured from the demand side grew by 2.4 percentage points slower than the real GDP as measured from supply side. For comparison, the discrepancies in current prices in the new accounts for 2011-12 were only 0.72 of the errors and omissions in the old accounts. The numbers for 2012-13 and 2013-14 were 0.08 and 0.04 respectively.

Nominal GDP Real GDP and the Deflator

The GDP is first estimated using current prices existing as of that period and such a GDP is called Nominal GDP. To compare the economic activity across time-periods the nominal GDP is adjusted for, by the economy wide inflation measure (-the GDP deflator) to calculate the Real GDP.

Real GDP = Nominal GDP -the GDP deflator

The issue is, which inflation measure shall we use as the GDP Deflator? The Consumer Price Inflation (CPI – a proxy for output prices) or the Wholesale Price Index (WPI – a proxy for input prices).  The GDP deflator used by CSO has more closely mirrored the WPI.

In recent times, these Inflation measures have diverged significantly, and hence the GDP growth rate will vary between 4% to nearly 12% depending on which measure of Inflation we use in the calculations. WPI has been in negative territory for a while, mainly due to falling commodity prices, including crude oil. CPI has still remained in the >5% ranges.

So far, there is nothing sinister, this method is consistent with UN-IMF methodology.

However, there are several question marks over the GDP deflator calculations, especially the estimation of Services deflator. To quote the relevant bits from the economists at HSBC and SocGen,[2]

“The really interesting/ dodgy thing here is that, as HSBC say, growth in the services deflator, which is infamous for high and sticky prices, was actually running below the industry deflator. Which is “odd because manufacturing and industry at large should be the prime beneficiaries of falling commodity prices and as such should run below services (which is largely non-tradable) inflation”

The suspicion is that deflators have been underestimated because the services deflator has been pegged more to the wholesale price index than to the consumer price index. And, er, it’s not a component in the India WPI basket.

While manufacturing is part of the WPI (and the GVA manufacturing deflator unsurprisingly follows WPI-manufacturing), services are not. Yet, the GDP service sector deflator mimicking the WPI raises a fundamental question as to how a component that does not exist in the WPI basket can be deflated by WPI.

With services accounting for about 60% of the GVA, the type of deflator used becomes crucial.

HSBC’s Pranjul Bhandari’s research also showed that there was an issue with the deflation of GVA growth calculations too.  Instead of deflating output and input with their respective prices, the statistics agency deflates both with a common output deflator.[9]

He concluded:

The practice of ‘single deflation’ instead of ‘double deflation’ exaggerated manufacturing growth by 450bp in FY16.. as the divergence between output and input prices soared.

Credibility issues

The biggest victim of this has been the credibility of the CSO.

In the past, people trusted India’s numbers. In case of China however, there was such a mistrust of official numbers, that some Chinese officials themselves looked at something called a Keqiang Index.

Worryingly, there is talk of having a Keqiang Index for India too, amongst other similar attempts.

In a period when most of micro level consumption and production indicators go down, you expect the macro level GDP growth to go down as well, but it didn’t. As a result, credibility of CSO numbers has suffered. RBI Governor, Government’s own CEA, several reputed international publications (The Economist, FT, Bloomberg and Forbes magazines) have remarked on this.The reason is that the numbers are contradicting a lot of other indicators. As pointed by an FT article [12]

…. these figures are hard to align with other evidence on the economy’s health…

the short point is that – as we have cautioned since the release of the revised GDP series last year – we should take the official GDP data, and the world-beating rates of growth they are suggesting, with a pinch of salt.

Also, an analysis of 189 nations over 33 years by the Reuters columnist Andy Mukherjee showed,

Never has an economy had such an handsome improvement in growth, even while recording a big improvement in external balances, as India claimed to have had in fiscal 2014.

India’s “new and improved” GDP statistics are asking investors to suspend their disbelief.

The World Bank original estimates had suggested India(7.5%) will grow faster than China (7.1%). India’s estimates have now been revised down to 7.2%,. But, there is every chance of us being faster than China for next few years.

No doubt, this is being trumpeted massively by propaganda as Mr Modi’s achievement.

However, If you look at any forecast (even the original BRIC report from 2001), this was always expected to happen – China’s one child policy that meant that they will face a problem with young workforce, whereas India is still a young country. The projections in the BRIC report had India still surging ahead till 2050’s or so, and China to slowdown around 2020.

It should also be noted, that since 1991, we grew faster than China in 1999, and nearly as fast as them in 2009 and 2010. (Using our old method, that underestimated the GDP).[8]

GDP Growth, or Development?

In summary, the UN-IMF system of GDP accounting was devised during a period of positive inflation when few thought 90 per cent of the world could face deflation in several parts of the economy and for periods ranging up to a year or more. The divergence in various inflation measures in recent times has exposed several issues with this methodology.

Even if we believe the numbers, headline GDP growth is not everything. Of course, poor countries need to grow fast if they are to tackle poverty. Yet, unless they lay the foundations for development — not only through appropriate reforms but also through investments in health and education — that growth can quickly peter out.

India lags behind its peers in measures of health, literacy and its record on improving the position of women. None of this bodes well for a country where, courtesy of a youthful population, almost one in five of all global jobs must be created in the next several decades.

References

1. The truth behind India’s new GDP numbers
2. India’s confusingly speedy economy and very own deflator problem, FT, Dec 2015
3. GDP Deflator misleading
4. when real GDP is higher than nominal, FE, June 2015
5. It is the deflation, stupid!
6. Few economists wholeheartedly believe India’s stellar growth rate, The Economist, Apr 9 2016
7. Real GDP is growing at 5% not 7.1%
8. The Economist Article – Catching the Dragon
9. India’s GDP to auto-correct – HSBC Research, Pranjul Bhandari, May 2016
10. Gross Domestic Perplexity
11. ‘Discrepancies’ drive GDP growth
12. Discrepancies and Indian GDP data, FT
13. India’s very own, updated, Li Keqiang Index – FT